COVID-19 Pullback: Pension Questions & Considerations Part One
Defined Benefit | Investment Manager Research | COVID-19 April 14, 2020
• The global outbreak of COVID-19 has led to significant declines in the majority of return-seeking asset classes year-to-date in 2020
• Liabilities and many liability-hedging assets such as long duration credit have also declined through the first quarter, primarily due to the widening of credit spreads to levels not seen since the 2008 Financial Crisis
• Funded statuses have likely declined year-to-date in 2020 coming off of a year in which many plans also lost ground on funded status due to falling interest rates and narrowing credit spreads
• With U.S. Treasury rates falling to historic lows, return-seeking assets falling materially and funded statuses likely lower, we will seek to help Plan Sponsors answer the following questions over the course of a series of white papers:
1. Where is my funded status today amidst current market volatility?
2. Did I make the right decision by adding liability-driven investments (LDI) to my portfolio, and with interest rates at all-time lows, does LDI still make sense?
3. Rebalancing and glidepath considerations: De-risk or re-risk, where do we go from here?
Where is my funded status today amidst current market volatility?
The short answer is likely lower. In 2019, funded statuses for most Plan Sponsors did not reflect the significant gains across asset classes due to the commensurate increase in liabilities during the year. The increase in liabilities was driven by a combination of declining U.S. Treasury yields and narrowing corporate bond credit spreads. A hypothetical 100 percent funded plan with an allocation of 60 percent global equity and 40 percent U.S. investment grade bonds lost approximately four percent of funded status in 2019, while a plan with 40 percent long government/credit fixed income exposure (longer duration) lost about two percent of funded status based on the return of the FTSE Pension Liability Index (individual plan experience varied by liability profile and duration).
The performance summary in Figure 1 from December 31, 2019 shows liabilities increased by at least 20 percent in 2019 depending on the interest sensitivity of expected future payments (duration). To summarize, plans did not see significant gains in funded status in what was one of the best years for asset class returns in recent history.
In 2020, funded statuses have likely continued to drop, but for very different reasons than in 2019. First, on the asset side of the equation, equities have declined significantly due to concerns regarding the spread of COVID-19 and the expected negative effects on company earnings and global economic output at large.
For bonds, 2020 has been a tale of two distinct periods: pre- and post-credit spread widening. At the end of February, even as global equities had declined by nearly 10 percent amid early fears of the spread of COVID-19, credit spreads remained within the same reasonably low range of the past three years, including the brief risk-off scare in the fourth quarter of 2018.
On March 9, as the S&P 500 fell 7.6 percent and made fresh lows below its 200-day moving average, Italy announced its national lockdown and right before the World Health Organization officially named COVID-19 a global pandemic, credit spreads finally began to widen out of their near-term range. At this point, bond portfolios with credit exposure began to decline in value, following their equity counterparts as seen in Figure 2.
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