Accelerating De-Risking Going Forward > High Incentives to Lock In Gains by Selling Equities in Favor of Long-Dated Bonds

Here's an explanation noted by Bloomberg in a few selected excerpts that goes like this

JPMorgan predicts that public pension funds run by states and local governments are also on course to shift more into fixed income. These public defined benefit plans, with about $4.5 trillion in assets, have a funding status that trails their private-sector peers, at about 60%.

MARKETS

Bonds Beat Stocks at Pension Funds, Turning 60/40 Inside Out

By

Liz McCormick

and

Lu Wang

‎April‎ ‎28‎, ‎2021‎ ‎3‎:‎00

• Top 100 public companies have over 50% of assets held in debt
• State, local government pensions to buy more, JPMorgan says

The debate over the traditional 60/40 portfolio seems endless, but for pensions at least, it’s over -- and bonds won.

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The retirement funds of the top 100 U.S. public companies, with combined assets of about $1.8 trillion, have ratcheted up their fixed-income allocations to a record level. At the end of their last fiscal year, they held 50.2% of assets in debt, while slashing money parked in equities to an all-time low of 31.9%, according to a recent report from pension advisory firm Milliman Inc.           

INSERT FROM BLACKROCK >

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The shift, part of a longer-term transition spurred by federal legislation that made fixed-income more appealing, is gaining momentum even though asset class returns have gone in opposite directions with stocks surging to record highs while a four-decade rally in U.S. bonds is in jeopardy.

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“So public pension funds have less incentive to de-risk in general,” Panigirtzoglou wrote. “But they do face a problem. Their equity allocation is already very high and their bond allocation stands at a record low of 20%. So, from an asset/liability mismatch point of view they are under some pressure to buy bonds.”

"... Paltry yields that seemingly have nowhere to go but up have been an almost universal worry that has prompted investors to question the wisdom of sticking with the long-favored portfolio diversification recommendation of 60% stocks and 40% bonds.

Ten-year Treasury yields have risen over a percentage point since August, nearly reaching 1.8%, as an improved vaccine rollout sparks business reopenings amid trillions in fiscal stimulus. The jump in yields resulted in the worst quarter for Treasuries since 1980, and has prompted Wall Street to predict even higher yields before year-end. Meanwhile, the S&P 500 index climbed 5.8% in the three months ended in March, the fourth consecutive quarterly increase.

Until last quarter, it’s mostly been the best of both worlds for pension funds, with equities outperforming long-duration debt even as yields plunged over the past few years. That generated gains that exceeded increases in pension liabilities. . .

The funding status -- a measure of the degree to which pensions have enough assets to meet liabilities -- of the 100 companies tracked by Milliman was 88.4%. Since 2005, the funds have also increased their allocations to “other” investments including private equity, real estate, hedge funds and money market securities to 17.9% from 9.5%. The majority of the companies have a fiscal year end that coincides with the calendar year end.

The Old 60-40 Formula for Stocks and Bonds Has Run Into Trouble 

 

 

“The main reason for the overall shift from equities into fixed income has had to do with the change in pension regulations,” said Zorast Wadia, a principal at Milliman. “And as these pensions’ funding status have improved they have continued to shed equity risk -- getting more and more into fixed income.”

Under the federal Pension Protection Act passed in 2006 companies had a set time to fully fund retirement plans and were required to use a specified market-based rate of return -- tied to corporate bond yields -- to compute liabilities rather than their own forecasts. This change made buying debt in an asset-liability matching framework more appealing than equities.

The American Rescue Plan Act of 2021, the most recent Covid-19 pandemic relief bill, provides two forms of general funding relief for single-employer pension plans. It’s not clear yet if that may affect asset allocation decisions.
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