Corporate pension funds had a boring year — if the only measure you look at is funded status.
After all, according to WTW data published recently, funded status — the amount a pension has on hand to meet obligations — stayed flat year-over-year at 95 percent. Goldman Sachs data on corporate plans, meanwhile, estimates that funded status increased, from 98 percent in 2021 to 100 percent in 2022.
But these numbers obfuscate the level of volatility that corporate plan investors faced in 2022.
According to WTW, which analyzed pension data for 356 Fortune 1000 companies with defined benefit plans, investment returns are estimated to have averaged –19 percent in 2022. Total corporate pension plan assets declined by 26 percent to $1.22 trillion for the year.
“It’s actually been a crazy year,” said Jason Wilhite, senior director of retirement at growth at WTW by phone. “If you [had] told me assets would go down by more than 25 percent over the year, I’d [have told] you funded status would go down.”
But that didn’t happen because of the unique relationship between interest rates and pension liabilities. When rates increase, pension plan liabilities fall — meaning corporations do not have to save as much to be able to pay retirees what they’re promised. (Pension liabilities are calculated based on long-term corporate bond yields — when they rise, the calculations actuaries use show liabilities falling.)
Here’s how it played out last year. Pension obligations fell by 26 percent in tandem with plan asset value, per WTW data. “It was a bit of a remarkable coincidence that both assets and liabilities fell by such a large but similar amount,” said Joe McDonald, senior partner at Aon, in a phone interview. Although 2022 may have been unkind to investment portfolios, it didn’t harm the health of corporate pension plans in the same way.
“Portfolio values did suffer, yet funded ratios remained pretty steady,” McDonald said.
Given the stability of funding, as well as the threat of an impending recession, more pension plans are now considering risk transfer transactions. These allow corporations to move their plans to third-parties, most often insurance companies. Under these arrangements, the insurance company manages the investments, takes on the risks of the portfolio, and is responsible for paying beneficiaries.
According to McDonald, the value of pension risk transfers reached roughly $50 billion, the largest year on record. He believes that activity in 2023 could be similar.
For some corporate pension plans, the task in 2023 will be to reconsider asset allocation, rather than to offload risk entirely. “There’s been a substantial repricing in all assets,” said one corporate pension CIO, who declined to comment on the record. “Equities are a lot cheaper. Bonds are substantially cheaper than they have been in the past years, so expected returns going forward are quite a bit higher. There’s reason to be optimistic.”
McDonald noted that Aon is advising some clients to diversify their fixed-income away from primarily holding Treasuries and investment-grade corporate bonds. Mortgages, insurance-linked securities, real estate debt, and private credit are all attractive options.
Delta Air Lines’ $16 billion pension plan is considering some of these assets, according to CIO Jon Glidden. Although Delta’s 2022 investment returns were negative, its funded status surpassed 100 percent in October of 2022 and then dropped off by year end to 98 percent, according to Glidden.
As a result, Glidden and his team increased the allocation to investment-grade fixed income and Treasury derivatives and sold off equity, REIT, and high-yield credit derivatives.
Delta’s investment strategy relies heavily on portable alpha, using derivatives to achieve all its beta exposure, and investing the rest of its capital into private assets and hedge funds. That beta overlay had been pretty equity-heavy for years, but in 2021, when Delta made its final contribution to the pension, the investment team revised its return target, dropping it from 9 percent to 7 percent. That allowed the fund to move away from equity derivative exposure ahead of 2022, when fixed-income returns finally started to rise again.
At the end of 2022, Delta cashed out of its investments in commodity trading advisor hedge funds. “It was an awesome year,” Glidden said by phone. “Part of the reason we held CTAs was to partially hedge equity exposure. Without equity exposure, we don’t need that anymore.”
The year’s winners? Tactical asset allocation managers and relative value fixed-income managers. “I continue to like the fixed-income relative value space with a degree of implied and realized volatility,” Glidden said.
Moving ahead, Glidden is looking at private credit investments, both to move away from assets that are marked to market and because valuations have come down. “The securitized world just got slammed last year,” he said. “Collateralized mortgage obligations, CLOs, asset-backed securities, and mezzanine tranches have started to look a bit interesting.”