Accounting

Disappearing Pension Gaps at America’s Largest Companies

A recent report from JP Morgan shows that pension gaps are disappearing.  One of the biggest contributors to the shrinking pension gaps has been the steady climb of the stock market. The S&P 500 rose 29.17 percent between the end of July 2012 and the end of January 2014. During that same time, the pensions included in the report slightly shifted allocation to stocks and away from bonds. From July 2012 to January 2014, stock allocations rose to 41 percent from 38 percent, while bond allocations fell to 38 percent from 41 percent. at America’s largest companies. The report, which was released on Feb. 14, says that the difference between pension assets and liabilities at the largest 100 American companies has shrunk to negative $140 billion as of January 31, 2014. That translates to a 91 percent pension funding ratio. That’s down from an all time high of negative $546 billion in July 2012. At the end of 2012, corporate pensions were funded at only a 77 percent rate.

The remainder of the pensions’ allocations are invested in a mix of cash and alternative investments like hedge funds and commodities. JP Morgan estimates that these investments had a return of nearly 10 percent over the same period.

While pension funds have slightly lowered their bond allocation over the past several years, there’s some indication that they may change. The surveyed pensions bought a combined $38 billion in bonds per quarter in both the second and third quarters of 2013. One reason may be the rise in bond yields during that time. Over the course of 2013, the yield on the 10-year Treasury increased from 1.86 percent to 3.04 percent.

Pensions also have added incentive to shift back to bonds. Many pensions have gap targets. With their gaps shrinking to the lowest levels in years, they may feel compelled to “lock in” those smaller gaps by shifting allocation to bonds, which are generally less volatile than equity investments.

The big question is whether pensions can maintain this tighter gap, especially since it is primarily due to investment results and not funding behavior. A significant drop in the stock market or a sharp increase in bond yields could easily cause gaps to expand.