By Vipal Monga And Mike Cherney
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.
International Business Machines Corp., Exxon Mobil Corp., and GM
are among the companies that have been vacuuming up
investment-grade corporate debt. But, because pension funds tend to
be buy-and-hold investors, their mass move into bonds is making it
increasingly hard to find the long-term, high-quality debt issues
the plans need.
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.
Write to Vipal Monga at vipal.monga@wsj.com and Mike Cherney at
mike.cherney@wsj.com
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