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Aug. 4 — World stock market gains in July slightly boosted the funding of large U.S. pension plans, but the post-Brexit low-interest-rate environment continues to pose risks, a pension consultant told Bloomberg BNA.
Uncertainty as to how the U.K.’s exit from the European Union will play out is likely to keep interest rates low, with repercussions for pension plan funding strategies, said Jim Ritchie, principal with Mercer's retirement business in Baltimore.
There has been a steady decline in interest rates for nearly 30 years, indicating what appears to be a sustainable trend, Ritchie said. It’s likely still a good time for pension plans to abandon their expectations of higher interest rates and consider de-risking strategies such as liability-driven investing that helps negate both stock market and interest rate risk, he said Aug. 4.
Ritchie’s comments follow Mercer's release on Aug. 3 of its monthly plan funding report. The report showed that the funding level of pension plans sponsored by Standard & Poor's 1500 companies went up one percentage point in July, because of strong world-wide stock market gains.
According to the report, the plans' aggregate funding level was at 77 percent at the end of July, up from 76 percent in June, Mercer said August 3.
The aggregate funding gains were because of the S&P 500-stock index rising by 3.6 percent in July and the MSCI EAFE, a key international stock index, moving 5.0 percent higher during the month.
Discount rates for pension plans, as measured by the Mercer Yield Curve, continued to drop in July, which increased plan liabilities, offsetting asset gains resulting from a cheery stock market. Rates decreased during the month by 12 basis points to 3.35 percent from 3.47 percent on June 30. Interest rates stood at 3.75 percent at the end of May, Mercer said.
The estimated aggregate assets of S&P 1500 companies at the end of July was $1.88 trillion, up from $1.83 trillion at the end of June. Estimated aggregate liabilities were $2.44 trillion at the close of July, compared with $2.40 trillion in June.
Ritchie said that recent stock market gains attributable to Brexit have appeared to stall, leaving plans with merely a low-interest rate environment to operate in.
He said there is no guarantee that interest rates will stay low, but that he’s seen a declining rate trend since 1989, when he first began tracking rates. Rates were similarly low during the early and mid-1990’s, Ritchie said.
Plans that accept Ritchie's prediction that low interest rates are likely to persist will be more comfortable with the idea of moving some plan assets into interest-rate-sensitive long-term corporate bonds, These plans should consider liability driven investing strategies, he said. Such strategies are designed to match a plan’s liabilities with its assets so that both stock market volatility and interest rates have less effect on the plan’s funding, he said.
Ritchie said that such a strategy can be done gradually, with better funded plans investing more heavily in long-term bonds. Poorly funded plans may benefit from keeping assets in the stock market, he said.
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Mercer's July funding report is at http://www.mercer.com/newsroom/July-2016-pension-funding.html.
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