US Pension Fund Fitness Tracker: Funded Status of Plans Marginally Improves in Fourth Quarter of 2012
CHICAGO--(BUSINESS WIRE)-- The UBS Global Asset Management US Pension Fund Fitness Tracker found that the typical US pension plan's funding ratio increased by less than one percentage point during the fourth quarter of 2012, remaining flat at 77%. Year to date, it is estimated that the funded status of plans has declined by one percentage point, in spite of tremendous volatility in both assets and liabilities.
The slight increase in funding ratio for the quarter was primarily driven by two factors:
• Equity markets were modestly positive over the quarter, reflecting both global central bank stimulus policies and generally improved economic sentiments; however, uncertainty in the US political arena due to both the US presidential election as well as the "fiscal cliff" negotiations weighed heavily on market sentiment. Fixed income assets showed mixed results, with increases 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 1% on a typical US pension plan's assets.
• Slightly underperforming asset returns, liability values were marginally higher over the quarter. US Treasury yields increased, while credit spreads tightened; the tightening in credit spreads offset the majority of the increases in yields, and subsequent declines in US Treasuries. The net result led to discount rates remaining flat to slightly up for the quarter, with liabilities gaining mainly due to the passage of time. For the quarter, pension discount rates are estimated to have increased by 1 to 5 basis points (bps).
For the quarter, a typical plan's asset pool returned approximately 0.7%, 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 fourth quarter, global markets were mainly driven by activities emanating from inside the United States. Unlike previous months, which were dominated by headlines pertaining to the longstanding European sovereign debt crisis, the US presidential election, as well as the impending US fiscal cliff negotiations, pervaded the economic landscape. In the US, the focus in October was directed toward the US presidential election and the impacts of Superstorm Sandy in the Northeast, while the focus in November and December was squarely placed on the status of congressional negotiations over progress on the fiscal cliff. Meanwhile, during the quarter, the US also saw generally mixed economic signals across leading indicators, the Federal Reserve's Federal Open Market Committee (FOMC) meetings and company earnings reports. Generally, the Fed remained committed to ongoing, open-ended, monetary stimulus, confirming both their commitment on stimulus as well as to keeping interest rates low until certain unemployment levels were attained.
Leading US economic indicators vacillated over the quarter, as the much-watched US employment reports indicated expansion in the employment market, but at a pace that generally would not help in reducing current unemployment levels in the US. However, on the bright side, GDP, while still tepid at 2% annualized growth, came in better than anticipated, and consumer confidence, as well as the US housing market, appears to be gaining strength. Furthering the economic uncertainty, the US earnings season turned out to be rather disappointing, as businesses appeared to be postponing investments on the back of regulatory uncertainty and the prospects of weaker demand.
Closing out the quarter in grand and dramatic style, leaders appeared to have reached a deal to avert the fiscal cliff on New Year's Eve, sending equity markets soaring to close out the year. In the eurozone, economic indicators surprised on the downside, with generally weaker-than-anticipated readings in GDP and consumer confidence. The bright spot economically came in the form of an agreement among European leaders to extend the support program for Greece, conditional on agreed reform measures and including concessions to Greece regarding longer long-term debt. The agreement led to further diminished tail risks from the European debt crisis.
Outside of the US and Europe, fears of a slowdown in the emerging markets, especially in the Far East, were alleviated when China's economy posted a 19-month high in manufacturing activity in December, as the Purchasing Managers' Index (PMI) rolled back to an expansionary reading, reversing course from the prior few months. Overall, the fourth quarter was far less volatile than previous quarters, as investors moved out of the "risk on/risk off" environment dominated by tail risks of the prior months and into an environment of general uncertainty largely precipitated by the US political process. In total, the S&P 500 Total Return Index finished the quarter down by less than 1%, while the MSCI EAFE Index ended the quarter up approximately 7%.
Turning to fixed income markets, US Treasury bonds generally sold off throughout the quarter, bouncing back and forth as the fiscal cliff negotiations were assessed. However, US credit bonds rallied throughout the quarter, continuing the theme from the prior quarter as investors reached for extra yield. In Europe, despite the appearance of alleviating tail risk with respect to Greece, government bonds declined on the heels of disappointing economic indicators across the member countries. Overall, the 10-year US Treasury bond yield increased by 13 bps, ending the quarter at 1.76%, while the 30-year US Treasury bond yield increased by 13 bps, ending at 2.95%. High-quality corporate bond credit spreads, as measured by the Barclays Capital Long Credit A+ option-adjusted spread, ended the quarter approximately 7 bps tighter. As a result, pension discount rates (which are based on the yield of high-quality investment grade corporate bonds) increased by approximately 1 to 5 bps. For the quarter, liabilities for a typical pension plan increased by less than 1%, as increases in discount rates were offset by liability growth attributed to the passage of time. (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 12/31/2011, 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 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.
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