Increased appetite fuels demand for highly rated debt issues
Corporate pension plans have become a force to be reckoned with in the bond markets.For the first time in more than a decade, large pension funds hold more bonds than stocks. Their increased appetite is fueling demand for highly rated debt issues, pushing up prices and driving down yields. That, in turn, could make it cheaper for companies to borrow money for years to come.
The trend is being driven by finance executives who have grown increasingly conscious of the risk underfunded pension plans pose to earnings. Last year ballooning pension obligations hurt the fourth-quarter profits of several large companies, including AT&T Inc, General Motors Co, and Kellogg Co.
“It’s just crippling to companies,” said John Jeffrey, a consultant at benefits adviser Conrad Siegel Actuaries. “They don’t know what’s coming.”
Companies with defined-benefit pension plans—those that guarantee a set payout—have been struggling to fund their obligations to retirees since 2008, when the recession sent asset values tumbling and liabilities soaring.
By increasing their holdings of long-term bonds, companies can more closely match their returns to their future commitments. Such asset-and-liability matching allows companies to limit the volatility of their pension obligations and lock in gains.
The strategy also can reduce the hit a company’s earnings might take if the value of its pension plan’s stockholdings fall, and can make a pension plan more attractive to outsiders, reducing the premium a company might have to pay to shift its pension burden to a third party.
GM, Verizon Communications Inc, and Bristol-Myers Squibb Co. , among others, have transferred more than $40 billion in pension obligations to insurers in the past three years.
The 50 largest defined benefit plans in the S&P 500 held 41% of their $941.7 billion in total assets in bonds last year and 37% in stocks, according to Goldman Sachs Asset Management. That’s the first time bonds have outweighed stocks since at least 2002, when the firm started tracking the data.
Last year, Meritor Inc. boosted the fixed-income holdings in its U.S. pension plan to 41% of the plan’s total assets from 36% the year before—an $88 million increase.
These days, however, it can take the company’s pension-plan managers more than a month to find the kind of bonds they want, and they may have to pay a premium for them. “It’s getting a little bit more challenging,” said Carl Anderson, the auto- and truck-parts maker’s treasurer.
The shift to bonds could accelerate in the coming years as the Federal Reserve debates whether to raise benchmark interest rates, said Rafael Silveira, a portfolio strategist at J.P. Morgan Asset Management. Such a move would increase rates offered on new bonds, making them more attractive to pension plans and other investors.
Yields on high-rated U.S. corporate bonds maturing in 10 years or more have been below 5% since March of last year. During the recession, yields topped 9%, according to Barclays PLC.
To be sure, some pension funds are still looking to invest more in the stock market in the short term to help their funding status. Underfunding generally increased last year as lower interest rates raised the current value of future payments promised to retirees.
A broader set of pension data based on the Russell 3000 Index, which tracks the 3,000 largest U.S. companies, shows that equities still outweigh bonds, according to J.P. Morgan Asset Management, by 50% to 39%.
Still, the moves by the bigger pension plans are significant. “Normally, the larger plans are the leaders in some trends,” said Mr. Silveira.
Stocks have the potential to return more than bonds, so having more stocks could juice asset values. But stocks are also riskier, and many companies would prefer to avoid the risks.
As more funds adopt the matching strategy, pension demand for long-term, investment-grade debt could total about $150 billion a year, said Michael Moran, pension strategist at Goldman Sachs Asset Management. That would be a sizable chunk of the market.
Last year, companies sold a record $604.9 billion of investment-grade bonds with maturities of 10 years or longer, according to Dealogic. That’s almost double the annual average of $318.3 billion since 1995.
Justin D’Ercole, head of U.S. investment-grade syndicate at Barclays, estimated that pension funds account for more than half of the buyers for new 40-year and 50-year corporate bonds. A few years ago, he would have pegged their share at around 25%.
Companies are seizing on that demand to raise capital. Last week, demand for 50-year bonds issued by Massachusetts Mutual Life Insurance Co. was so strong that the company raked in $500 million, much more than its originally planned $350 million. In February, Microsoft Corp. sold $2.25 billion of bonds maturing in 40 years.
The fact that retirees are living longer is something companies must face. New accounting standards on life expectancy issued late last year are forcing more finance executives to increase the size of their pension obligations. That’s compelling many to consider how they want to carry that burden on their balance sheets.
GM began actively matching its pension assets with its obligations about five years ago, after emerging from bankruptcy proceedings, said Dhivya Suryadevara, chief executive and chief investment officer of the auto maker’s asset-management division.
The market crash of 2008 reminded corporate executives of the risks that falling interest rates and stock prices posed to their balance sheets, said Ms. Suryadevara. She said that moving into bonds earlier than most helped GM get ahead of the competition.
GM’s U.S. pension plan, which is 86% funded, holds roughly 60% of its assets in bonds, up from about 42% in 2009.
Because of its size, the company has to be careful when buying bonds. “You don’t want to tilt the market,” she said.
Collectively, however, corporate pensions are doing just that.
Vipal Monga and Mike Cherney - Wall Street Journal
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