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US Pension Fund Fitness Tracker: Funded Status of Plans Improves in First Quarter of 2013
Chicago, April 4, 2013 11:00AM– The UBS Global Asset Management US Pension Fund Fitness Tracker found that the typical US pension plan’s funding ratio increased by nearly five percentage points during the first quarter of 2013, rising to 82%.
“Similar to the first quarters of the past two years, the first quarter of 2013 has been quite favorable for US pension plans," said Jodan Ledford, an Executive Director within UBS’s Retirement and Advisory Solutions group. “Sponsors that have already adopted pension risk management frameworks were able to lock in funding ratio improvements over the quarter. Many sponsors that have not adopted a risk management program may want to consider derisking a portion of their plans to preserve the improvement in funding ratio experienced over the first quarter.”
The increase in funding ratio for the quarter was primarily driven by two factors:
- Equity markets were strongly positive over the quarter. The fiscal sequestration in the US and political uncertainty in Italy were not enough to derail the strong upward move in equity markets. Fixed income assets were mostly down, with slight decreases across credit bonds outperforming declines in both the US government bond markets and international government bonds. Cumulatively, aggregate performance of the capital markets led to an increase of nearly 4.7% on a typical US pension plan’s assets.
- Underperforming asset returns, liability values fell 1.6% over the quarter. US Treasury yields increased, while credit spreads widened only 1 basis point (bps); the net result led to discount rates increasing over the quarter, which, in turn, led to declines in liabilities. For the quarter, pension discount rates are estimated to have increased by approximately 10 to 15 bps.
For the quarter, a typical plan’s asset pool returned approximately 4.7%, based on the average corporate plan's reported asset allocation weightings from the UBS Global Asset Management Pension 500 Database and publicly available benchmark information.
In the first quarter, global markets were mainly driven by activities emanating from the US and Europe. Absent any overarching story, emerging markets have been slightly more fragmented and directionless. Risky asset classes, including lower-quality assets, have experienced an impressive rally based on positive global sentiment and a sharp repricing of risk premia. US stocks reached levels last seen in 2007, as the Chicago Board Options Exchange Market Volatility Index (VIX) index also returned to 2007 levels. In a string of positive news, US home sales expanded at their strongest pace since the third quarter of 2009, and European banks repaid a larger-than-expected amount of the European Central Bank’s (ECB) long-term refinancing operation (LTRO).
With the sequestration cuts in the US and following the inconclusive election in Italy, political uncertainties emerged again, and will likely spur volatility for some time. Nevertheless, there is some confidence in the markets that the automatic spending cuts of $85 billion due to the sequestration will not be able to derail the US economy from its current trajectory of moderate growth. In our view, any steps to improve the budget can be seen as positive, while at the same time, we believe the sequestration will likely force the US Federal Reserve (Fed) to stay accommodative for longer.
Macro data coming from the US in March was generally supportive, but also mixed. While the outlook for the labor market improved, consumer sentiment deteriorated, which on balance will likely keep the Fed from retrenching prematurely. Toward the end of the quarter, developments in Europe weighed on global equity markets, as Italy struggled to form a coalition government and Cyprus was bailed out, though Cyprus ultimately avoided a sovereign default and potential eurozone exit. In total, the S&P 500 Total Return Index finished the quarter up 10.6%, while the MSCI EAFE Index ended the quarter up approximately 9.8%.
Turning to fixed income markets, US Treasury bonds and US credit bonds generally sold off throughout the quarter. Overall, the yield on 10-year US Treasury bonds increased by 9 bps, ending the quarter at 1.85%, while the yield on 30-year US Treasury bonds increased by 15 bps, ending at 3.10%. High-quality corporate bond credit spreads, as measured by the Barclays Capital Long Credit A+ option-adjusted spread, ended the quarter 1 bps wider. As a result, pension discount rates (which are based on the yield of high-quality investment grade corporate bonds) increased by approximately 10 to 15 bps. For the quarter, liabilities for a typical pension plan decreased by 1.6%. (Please see disclosures for assumptions and methodology.)
Disclosures and methodology
Funding ratios measure a pension fund’s ability to meet future payout obligations to plan participants. The main factors impacting the funding ratio of a typical US defined benefit plan are equity market returns, which grow (or shrink) the asset pool from which plan participants’ benefits are paid, and liability returns, which move inversely to interest rates.
Liability indices: Methodology
The iBoxx US Pension Liability Index – Aggregate mimics the overall performance of a model defined benefit plan in the US, taking into consideration the passage of time and changes in the term structure of interest rates. The index is based on actual liability profiles, and mimics the investment grade yield curve. It is therefore more appropriate than most existing indices for measuring the performance of defined benefit plans. This index (along with its related active member and retired member indices) is published daily, using the LIBOR interest rate swap curve as the discount curve, a highly liquid universe. This provides the flexibility to use combinations of the indices in order to accurately represent customized liability profiles based on a plan’s specific participant population.
Pension Protection Act (PPA) liability returns are approximated by the Barclays Capital US Long Credit A-AAA Index. This index broadly reflects the duration and credit characteristics of the PPA discount curve that is used to discount expected pension benefit payments for US defined benefit pension plans.
Asset index: Methodology
UBS Global Asset Management approximates the return for the ”typical” US defined benefit plan using the reported asset allocation of the UBS Global Asset Management Pension 500 Database. The series is constructed using the aggregate asset allocation weightings and publicly available benchmark information, with geometrically linked monthly total returns. As of December 31, 2011, the asset index has been recalibrated based on the aggregate funding level of the participating plans in the UBS Global Asset Management Pension 500 Database, reflecting plan sponsor contributions over 2011.
Pension Fund Fitness Tracker: Methodology
The US Pension Funds Fitness Tracker is the ratio of the asset index over the liability index. Assuming all other factors remain constant, it combines asset and liability returns and measures the impact of a “typical” investment strategy on the funding ratio of a model defined benefit plan in the US due to interest rollup, change in interest rates and typical asset performance, but excludes unique plan factors, such as service cost and benefit payments.
The UBS Global Asset Management Pension 500 Database
The UBS Global Asset Management Pension 500 Database is a proprietary database that is based on the analysis of 500 public companies sponsoring large defined benefit plans. The information was extracted from the companies’ 10-K statements. The study may include figures for companies’ nonqualified and foreign plans, both of which are not subject to ERISA.
The aggregate asset allocation is based on an equally weighted average of the 500 companies included in the database. The aggregate asset allocation includes equities, fixed income, hedge funds, private equity, real estate, and cash.