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November 11, 1997
Surviving Black Monday :
Pension funds leave equity allocations intact after the Dow's plunge.
You hear it again and again: Stocks yield the best returns over the long haul. But the Dow's record 554-point plunge in late October was a harsh reminder that the asset class promising the biggest payback also carries some big risks. Fortunately, many big plan sponsors were prepared for the jolt - at least mentally, if not through measures they had already taken to protect themselves. Some had started to shift more of their portfolios into fixed income over the past year, for example, and found this a useful cushion to the shock wave that passed through the market on October 27.
"We had begun to be cautious toward equities last year, and had reduced our US equity exposure from our long-term target of 50% to a lower 45%," says Gene Bolton, head of equity investments at GE Investment Management, which manages $68 billion in assets, including General Electric's $38 billion pension plan. But rebalancing was difficult in a fast-rising market. As stocks redoubled their surge, beginning last December, GE's exposure bounced back to 48%.
concern is corporate earnings
"From here, it's hard to see the market going much higher for a while," Bolton said just a week after the market landslide, when the Dow hovered at around 7,680 points. "Our biggest concern is corporate earnings in '98. With the high valuations, it's appropriate to be in the lower [end] of our [equity allocation] range. But we don't tend to make big changes. We won't have less equities than 3% to 5% below our target."
Apparently, 401(k) plan participants were also psychologically prepared for a precipitous stock market decline. Participant transfer activity at Sedgwick Noble Lowndes' daily valuation unit doubled the normal rate in the days following the correction, but was still quite small. Each day, only about .5% of the 15,000 participants for whom Sedgwick provides daily valuation services made any sort of funds transfer. That "perhaps indicates that 401(k) investors are learning to take a longer-term view of their retirement investments and ride out market fluctuations", says Mary Simcox, senior vice president and national practice leader for defined contribution plans at Sedgwick in Roseland, New Jersey.
Greg Metzger, a senior defined contribution plan consultant with Watson Wyatt Worldwide in Los Angeles, agrees that this time around, participants' tolerance for market turmoil was unusually high. "A lot of [Watson's defined contribution plan clients] called to see what their balances were, but there were very few changes, which is different from other corrections," says Metzger. "There has been so much communication, and the previous corrections in the '8O's or '90's have been such buying opportunities. Plus [participants] heard not to sell low. Some employees now are moving to fixed income. And those who had been venturing in international assets come back to domestic equities.
activity remained normal
Tom Pavey, vice president in charge of the administration of American Express' retirement plans, which include an $800 million defined benefit plan and a $2 billion 401(k) plan says, "We've had three times the normal number of calls, primarily on Tuesday following the market drop, but the participants were only checking prices and balances. The transfer activity remained normal."
But while stocks still have strong support, bonds are becoming increasingly attractive - especially to pension sponsors worried about the effects of the East Asian financial meltdown on US companies' profitability . "The Far East slowdown is deflationary, or at least puts a limit on how much inflation could rise in the US," notes GE's Bolton. "We increased our [fixed income] exposure, as there is not a lot of risk of seeing interest rates back up sharply," says GE's Bolton. We increased our [fixed income] exposure by a couple of [percentage points] three months ago," and the fund now has 19% in this asset class.
Some pension funds, with as much as 70% to 75% of assets in equities, "realized this kind of exposure produces volatility," explains Thomas McMahon, senior vice president of finance and administration at Pacific Maritime Association, a $1.75 billion multiemployer plan. PMA's defined benefit fund, happily, decrease its equity allocation from 70% down to its target exposure of 55% to 60% in September, McMahon says.
to face pension liabilities
"[Equity] valuations and expectations are very high," says GE's Bolton. But GE plans no big changes in its approach as a result. In the future, he says, GE Investments "will stay modestly below our target" equity allocation, but the fund plans no major changes as a result of the October mini-crash. "We'll have a lot of pension liabilities to face in the next 30 years," he says, and the compagny is betting that equities will produce the superior returns needed to meet them.
The bottom line: Pension and endowment funds, as long-term investors, remain firmly committed to the higher levels of equity investment they have adopted in recent years. "I don't discuss short-term moves. They're our secret," says Jack Meyer, president and CEO of Harvard Management Company, which manages $12 billion in endowment money for the university. But the fund's long-term asset allocation target was - and remains - 19% bonds, - "including the high yield ones, and 75% equities, with the remainder in commodities and real estate," Meyer says.
American Express' Pavey shares this long-term approach. "When you put an asset allocation in place, you need to stick to it and not react to quick changes in the market," he says. "Our target balance is 75% equities and 25% fixed income. Our investment committee routinely reviews our strategy, but it doesn't change it because of short-term events.Gilles Pouzin