U.S. pensions slash expectations for investment returns

U.S. pension funds are slashing their projected investment returns from major asset classes through 2013, prompting some to predict the impending death of defined benefit (DB) pension plans in that country, according to a study.

Greenwich Associates’ survey of 1,000 U.S. institutions regarding their expected annual rates of return on individual asset classes for the next five years reveals that corporate pension funds have reduced investment returns expectations on plan assets to an annual 7.4% in 2008 from 8.2% in 2007, while public funds cut overall portfolio return expectations to 7.6% from 8.5%.

“U.S. pension funds are not expecting a quick recovery in investment markets,” says Greenwich Associates consultant William Wechsler. “To the contrary, they are planning for a slow-growth environment for asset valuations that they expect to continue for the next five years.”

Pension funds have reduced return expectations for U.S. equities, projecting a drop in annual rates of return to 7.8% in 2008 from 8.6% in 2007 among corporate plans and to 7.9% from 9.1% among public plans.

Return expectations on fixed income have also dropped, with public plans reducing annual expectations to 5.0% from 5.8% and corporate plans reducing expected returns to 5.2% from 5.6%. Respondents also reported substantial reductions in expected returns on international equity, equity real estate, private equity and hedge funds.

Private equity is expected to generate the highest returns of any asset class over the next five years, with public funds projecting an annual 11.3% return from their private equity investments and corporate funds expecting 10.1%.

The results of the study suggest that institutions believe a low return environment will persist for some time to come, resulting in severe resource constraints for companies, states, municipalities and other plan sponsors. Rather than being in a position to increase contributions, many plan sponsors are reducing or delaying contributions in an effort to save money, but these actions could serve to increase pension funding shortfalls over the long term. Some will be at risk of violating regulatory requirements, and in the current environment may seek relief from the government.

“We might look back at this crisis as being the final stake in the heart of corporate defined benefit pension plans in the United States,” says William Wechsler. “Recent volatility in pension asset valuations is bringing home the risks these plans can pose to the bottom line, and unfortunately closing plans to new employees is a relatively easy way for companies to reduce pension costs.”

(02/03/09)