October 6, 2013

U.S. Pension Plan Allocation Strategy

Recent data from the U.S. Census Bureau gave an updated look at how the largest 100 public-employee pensions are allocating their investments. It is an interesting report because, like a retired investor, a pension has to contend with income distributions and longer-than-expected life-spans. A pension also shares characteristics with an investor who is still employed full-time and faces both future liabilities (meaning money for living expenses) and the need to achieve enough growth to meet those liabilities.
At the end of the second quarter of 2013, corporate stocks (which include private equity, venture capital and leveraged buyouts) accounted for 34.4% of total cash and securities holdings. International securities comprised 20.1% of public-employee pensions. Corporate bonds had an 11.1% allocation. A 9.1% allocation was assigned to federal government securities.

You might notice the exclusion of approximately one-quarter of the pension portfolios’ allocation. The summary document I am using does not specifically break out the percentage of pension assets held in cash. Due to the government shutdown, the Census Bureau’s website is blocking access to statistical data, making the details unavailable. I can say that, based on the numbers above, cash accounts for no more than a 25% weighting.
What is notable about the allocations is that even in the current environment, pensions have significant exposure to both stocks and bonds. The equity component provides growth to overcome the risk of inflation. The bond component provides income and diversification. It’s an important mix because pensions have to balance both current and future liabilities.

Granted, there are several public pensions that lack the assets to meet their future obligations. For both public and private pensions, this more often reflects underfunding and return assumptions that were too optimistic. Individuals face the same potential problems. Failing to save enough and counting on too high a level of returns leads to inadequate savings. (Bad investment choices on the part of pension investment committees and individual investors are also a cause of inadequate portfolio balances.)

What may not be immediately apparent from the data is the total return approach followed. Pensions and endowments do not adhere to the “never touch principal” philosophy. Rather, they look to their entire portfolio to fund distributions. This focus on total return allows them to take advantage of what the market gives them, as opposed to trying to fit a square peg into a round hole. Focusing on total return works for pensions and endowments, which have regular distribution requirements, and it works for retirees depending on their portfolios for income too.

The Week Ahead

Third-quarter earnings season officially starts with 10 members of the S&P 500 reporting. Included in this group are Alcoa (AA) and Yum! Brands (YUM) on Tuesday, Costco Wholesale Corp. (COST) on Wednesday, and Wells Fargo & Co. (WFC) and Dow component JPMorgan Chase (JPM) on Friday.

What economic data we will actually see will depend on how long the government is shut down. The September jobs data scheduled for release tomorrow (October 4, 2013) will not be published until the shutdown ends. Next week, August international trade (Tuesday), August wholesale trade (Wednesday), September import and export prices (Thursday), the September Producer Price Index (Friday), September retail sales (Friday) and August business inventories (Friday) could all be delayed. It looks like the weekly initial jobless claims data will be released on Thursday even if the shutdown continues, but I’m not certain. Not impacted by the shutdown will be the release of the minutes from the September Federal Open Market Committee meeting (Wednesday) and the preliminary October University of Michigan consumer confidence survey.

The Treasury Department will auction $30 billion of three-year notes on Tuesday, $21 billion of 10-year notes on Wednesday and $13 billion of 30-year notes on Thursday. These auctions will occur even if the government remains shut down.

Four Federal Reserve officials will make public appearances. Cleveland president Sandra Pianalto and Philadelphia president Charles Plosser will speak on Tuesday. St. Louis president James Bullard and San Francisco president John Williams will speak on Thursday. 
About The Author - Charles Rotblut, CFA is  the VP and Editor for American Association of Individual Investors (AAII).  Charles is also the author of Better Good than Lucky.  (EconMatters author archive here

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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