The sands shift
December 2009 may have marked the end of the downturn in US for the job market and retirement savings, after two very tough years. There were signs of stabilisation with companies starting to hire again, while employees who survived received statements from their pension funds that were no longer horrible. Even though 2010 begins on a positive note, there are still challenges ahead for the US pension industry.
According to the Vanguard Group and Fidelity Investments - the two major providers of 401(k) plans (individual defined contribution accounts) - millions of US employees have recovered most of the losses of the last bear market. Vanguard looked at participant balances between September 2007 and September 2009, and said that 60% of members who continued to contribute and stayed invested had more money in their accounts than in September 2007, the peak of the previous bull market. Among the 40% with lower balances, the majority were less than 20% below their earlier peak value.
Fidelity analysed its clients’ 401(k) account balances at the end of 2009 third quarter and found that on average they were up 13% from the end of the prior quarter but, when additional contributions from individuals and their company were excluded, the median one-year rate of return for participants was only 0.4%. Not a huge number, but according to Michael Doshier, Fidelity’s vice-president of the workplace investing group, it is significant that the number turned positive much sooner than expected.
This improvement has not turned the US authorities’ attention away from how 401(k)s work and are invested. Last month the Securities and Exchange Commission’s (SEC) chairman Mary Schapiro promised to focus in 2010 on creating a “strong fiduciary standard” for all securities professionals, including pension fund consultants and providers. One problem she wants to tackle is target date funds, which are being used more often in 401(k)s, and which have come in for criticism because of high expense ratios and a lack of transparency about investment strategies.
Another regulatory issue in the pension industry is the role of placement agents, who are often used by private equity firms to solicit business from government pension fund clients. The SEC is proposing to ban this practice after the New York attorney general discovered a web of connections between placement agent firms, investment firms and public retirement systems across the US, where pay-to-play schemes sometimes involved bribery.
State pension funds, such as New York and the California Public Employees’ Retirement System, also face the risk of big deficits because of rising benefits and investment losses, while state governments are experiencing declining tax revenues and cannot afford further contributions. To avoid bankruptcy, last month the New York State Assembly approved a change to its public pension system to raise the retirement age and financial contributions for new employees hired from 1 January 2010. This will save local governments about $48bn (€32.3bn) over 30 years. Other states are expected to follow.
Another US institution in serious trouble is the Pension Benefit Guaranty Corporation (PBGC), the federal corporation that guarantees payment of basic pension benefits for 44m US employees and retirees in more than 29,000 private-sector defined benefit plans. President Obama has appointed Joshua Gotbaum, an operating partner at New York-based private equity firm Blue Wolf Capital - and who formerly served in the Bill Clinton administration - to head the PBGC, after its former director Charles Millard had to resign amid allegations that he had improper relationships with some Wall Street firms. Gotbaum will have to deal with a record $22bn deficit, ballooned by the unfunded pension plans of failed companies, which will require a new investment policy.
Millard had decided to abandon the old conservative liability-driven strategy and invest 45% of the PBGC’s $64bn assets in equities, 45% in fixed income and 10% in alternatives. The PBGC’s board has suspended this plan and reallocated its assets: as of 30 September 2009 its allocation was 60% in cash/fixed income and 37% in equities.
An increasing number of DB pension plans in the private sector are adopting the same approach and buying investment-grade corporate bonds in particular, which is encouraged by the Pension Protection Act of 2006. The legislation discounts liabilities against high-rated investment-grade debt, and requires funds to be fully funded. In order to comply, companies are switching to corporate bonds.