US pension funds have shed a trillion dollars of value in the last three years, and now face a serious under-funding crisis. Or so says a 2002 study by Greenwich Associates , whose consultant Dev Clifford calls the 2000-2002 period “probably the most destructive in the whole history of the U.S. fund business.”
Just two years ago, fewer than 10% of US corporate funds were underfunded. By the start of 2002, nearly 30% were. This has only worsened in the past year. The balance of existing funds against the projected benefits obligations among corporate funds fell from 121% to 103% in just two years. Among corporate funds with over $5 billion in assets, the drop was more severe yet, from 125% to 99%. “Falling below 100% is just about the worst thing a pension fund can do, and will require serious review,” consultant Chris McNickle warns. The news was bad at public funds, too, where the percentage of underfunded funds rose from 46% to 52% overall, and from 48% to 58% among those funds with over $5 billion in assets.
Things are particularly bad for corporate pension funds, where year-on-year losses have been severe and became even more so in 2002. According to a matched sample of 380 large corporate funds who have interviewed with Greenwich Associates for each of the past three years, the average decline in 2002 was 14.6%, sharper even than the 10.1% loss sustained by corporate pension funds last year.
Among public funds, the diminution was less substantial but hardly minor. A matched sample of 199 public pension funds revealed average asset losses of 9.3% from 2001 to 2002, slightly worse than the 8.9% reduction seen from 2000 to 2001.
Endowments and foundations fared “best,” losing 6.3% of their value in 2001-2002, as opposed to 5.9% of their value in 2000-2001, according to a matched sampling of 125 non-profit funds. “Anyway you look at it, it was a rugged year for pension fund and endowment managers,” consultant Rodger Smith says.
From representing more than half the total asset mix just two years ago, domestic equity fell sharply in terms of proportionate investment, from 49.4% in 2001 to 46.8% 2002. Fixed income investment rose nearly as much, from 26.4% to 27.8%.
“Looking at the asset mix differences between fund types gives you a sense why they performed differently in the current market,” consultant John Webster notes. “Corporate funds are the most heavily invested in domestic equity, including in the case of many defined contribution plans, in a corporation’s own stock. Public funds, meanwhile, hold the largest proportion of fixed-income investment, mitigating the pain of poor market performance.”
Endowments are the most heavily invested in alternative asset classes, namely private equity and hedge funds. These two, along with the less novel alternative category of equity real estate, picked up many new institutional investors in 2002, pension funds as well as endowments, and more of this is expected in years to come. Yet these classes still represent a miniscule part of the total picture, just 7.5% of total institutional assets.
Overall, for more than 1,000 corporate and public funds, the actuarial earnings rate of return assumptions were marginally lower in 2002 than in 2001, 8.8% in 2001, 8.6% in 2002, according to data gathered by Greenwich Associates in the fall of 2002. On average, public funds reduced their assumptions from 8.3% to 8.0%. Yet corporate funds stayed level – 8.9% in both years.
Less than a quarter (24%) of corporate funds changed their rates last year. Consultant William Wechsler comments: “While it may not be right to adjust actuarial assumptions as they cover 20 or more years, the average rate of return expectations of both corporate and public funds are so much lower that – overall – they don’t have a prayer of reaching their actuarial assumptions in the foreseeable future.”
It should be noted that more corporate funds have been reported of late to be in the process of significant downward revision in their actuarial assumptions, with most reducing them below 9.0%. John Webster calls this “a welcome return to reality.”
Average compensation rose among fund officials in total and across all fund types, according to Greenwich Associates research. On average, pension officials reported earning $136,600 in total compensation in 2002, driven in large part by an increase in salary. The average bonus actually dipped slightly. Endowment officials actually do better than those at corporate funds, earning $156,100 while corporate officials receive $148,600. Public officials continue to lag their peers, with an average total compensation package of $98,800, up from $94,800 in 2001.
From August to October, 2002, Greenwich Associates interviewed fund professionals at 574 corporate funds, 246 public funds, and 212 endowments and foundations in the United States. Interview participants were asked about their investment-service providers, their business practices and philosophy, and their future expectations.