Tuesday, October 19, 2010

Pension Funds, Equities & Equity Market Performance In The Near Term

Yesterday's Wall Street Journal featured a long article detailing how US corporate and union pensions have taken dramatic steps to limit their exposure to and investments in equities.

Even as the percentage of funded pension obligations among S&P 500 companies fell from over 100% in 2007 to less than 75% this year, there's evidently a stampede among them to more closely fund expected pension payments and stop focusing on longer term total returns.

Of course, long term total return-focused investing has been, for years, synonymous with large percentage holdings of US equities.

In a chart comparing 2005 equity investments to 2009, major company pension funds exhibited declines from the 60-70% range down to 30-50%.

That's a stunning drop for such large institutional investors. One assumes that union and other pension funds have behaved similarly.

The reason, of course, is the so-called 'lost decade' in equity performance from 2000-2009.  The Journal piece states that state and local governments "oversee $2.8 trillion in assets," while corporate pensions assets are roughly $2 trillion.

Another solution is a move to cap and close current defined-benefit plans, shifting to 401K plans held by individuals for future pension obligations.

With this excellent article as fresh information on the motivations, current and planned moves of some $5 trillion of institutional assets from equities to fixed income, my question is this.

Will the rush of so much money reputed to be 'on the sidelines,' about to pour into US equities in order to catch up to the current year S&P's ~4% return, still occur?

With US pension funds holding back from equities, will hedge funds alone be sufficient to cause the prophesied, magical lift in the fourth quarter for US equity indices?

If one believes the Journal article, a very large amount of assets are shifting away from US equities in a secular fashion. It doesn't mean shorter-term trends won't still be intact, but it would seem that the levels at which those trends occur will be lower.

Various estimates of the current US equity markets capitalization range from $35-40 trillion. At that level, $5 trillion in wary institutional assets represents between 1/8 and 1/7 of the market. That would seem to be a non-trivial chunk of assets which aren't going to be rushing into a rising US equity market.

Perhaps, regardless of employment or US corporate earnings, equity indices such as the S&P500 and Dow Jones are going to experience muted rises in the next few years, as fewer assets stream into rising markets.

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