Despite Fed-watching" becoming the favoured hobby in Wall Street of late, there seems little to worry about on the bond front as far as American Airlines (AA) pension fund is concerned.

Which is a good thing seeing as 50% of its master plan is invested in long-duration US bonds.

Nancy Eckl, vice president, trust investments at AA's offices in Fort Worth is quietly confident. "Short term interest rates will probably end the year 5.75% to 6%, and probably on the long term rates there will not be much change from where we are today."

The master plan, worth $4.3bn, covers the bulk of the airline's employees with the targeted asset allocation of 50% long-duration US bonds aimed at combatting any changes the Federal Reserve might make. "The purpose of that portfolio is that it is set up as a hedge against changes in interest rates" explains Eckl, "As the liability goes up or down in response to interest rate changes, the portfolio should offset it using about half of the assets with twice the duration of the liability."

The remainder of the plan is largely equity-driven, with a 25% allocation to US stocks, 15% to EAFE stocks, 5% allocation to emerging markets stocks and bonds, and the remaining 5% for illiquid in-vestments, "private equity and the like", says Eckl.

AA also has a second plan specifically for the pilots, a variable benefit plan worth $2.7bn. In contrast the secondary plan is purely equity invested, divided into 75% US equity, 20% EAFE equity and 5% emerging markets equities, a turnaround to the comparatively conservative main scheme.

"It is a supplementary plan to an already fairly generous defined benefit plan." she explains. "Therefore more risk could be taken with respect to that plan." It has done very well so far on its investments. "The returns there have really been extraordinary" she says.

Equity performance might not be as spectacular this year, and Eckl is expecting a return to normality. "We would view this year as being a more normal type year in terms of the long term historical type averages." She does not view inflation as a problem, predicting it will remain "contained", but warns of a rocky time ahead for stocks. "Go-ing into the year we thought the first half would be stronger than the second. There is a risk of plenty of bumps along the road and even as much as a 10% type correction."

However, she is not expecting any dramatic tumbles on the market and by the end of the second half is looking for returns in the "high single digits, 7 to 9%."

Individual sectors such as energy, consumer cyclicals, staples, health and finance are doing well, the latter area being a traditional favourite with the pension fund. "We have tended to be overweighted in financial stocks - they tend to be cheaper than other stocks, and again with the consolidations there are still some cost savings to be recognised there."

AA underwent "a fairly significant asset allocation change" late last year, reducing their heavy exposure to the bond markets and in turn increasing their equity weighting. "Historically in addition to that 50% of the portfolio that had been in-vested in the long duration bonds, we kind of treated the other half of the plan as if it was more of a traditional stand-alone pension plan with 60% stocks and 40% bonds - ignoring the fact that 50% of the plan was already entirely in bonds." says Eckl.

The fund is not planning to alter the asset allocation of either funds for the foreseeable future. "Our long-term view of the market is that equity should outperform , so this revised asset allocation makes sense. We're not trying to time the markets, we don't believe in timing the markets. Long term views are what drive our asset allocation de-cisions, not short term views of what's happening over the next few months or the year."

Rachel Oliver"

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