Efforts to change pension plan reporting rules could transform allocation of U.S. pension assets and reshape the market for bonds and other debt securities.[@@]

Pension fund experts made those predictions here Thursday at a seminar sponsored by a unit of Merrill Lynch & Company Inc., New York.

Although defined benefit pension plans cover only 20% of the U.S. work force and suffer from at least $500 billion in underfunding, they still hold about $12 trillion in assets, according to Robert Doll, chief investment officer at Merrill Lynch Investment Managers, New York.

The Financial Accounting Standards Board, Norwalk, Conn., has been considering a proposal to eliminate investment performance rules that permit “smoothing” of what appear to be temporary fluctuations in the value of the stocks in pension plan portfolios.

FASB has postponed the possibility that it might adopt a ban on volatility smoothing for at least a year.

But the Committee on the Investment of Employee Benefit Assets, Bethesda, Md., has predicted that adoption of the anti-smoothing proposal could cut pension plan stock allocations about 13%, according to Chet Ragavan, head of global fixed-income research at Merrill Lynch Investment Managers.

Forecasts of the value of the shift range from a low projection of $215 billion by analysts at Merrill Lynch to a high projection of $650 billion released by analysts at other firms, Ragavan said.

The shift would affect only a small portion of pension plan assets and U.S. stock assets. Investors have put a total of $17 trillion in U.S. stocks, Ragavan said.

But one way for pension fund managers to cope with FASB reporting changes might be to buy long-term debt securities, and that would lead to “massive demand for the long-duration bond,” said Gordon Latter, a senior pensions strategist at Merrill Lynch.

Government issuers do not seem to be selling enough fixed-income securities to keep pace with demand, and corporations already are starting to respond to the changes in buyer preferences by issuing debt securities with longer durations, Ragavan said.

Ragavan predicted the shift toward fixed-income securities with longer durations will become more evident over the next 5 years.

Latter suggested that pension fund managers might cope with FASB changes by making more use of interest rate swaps, or contracts that allow one party to trade interest rates with another party.