Company pensions are nearing a tipping point that’s poised to send them on a buying spree in the U.S. corporate bond market.
The retirement plans, helped by gains in stocks, are edging closer to digging themselves out of a hole they’ve been in for more than a decade, a shift that is cutting their demand for risky assets like equities and stoking their interest in more stable investments like company debt.
Companies on average have about 82% of the funding they expect to require for retirees’ pensions, compared with around 75% in the middle of last year, according to strategists at Morgan Stanley. Once pensions are around 80% funded, they tend to increase their bond holdings and cut their stock investments to lock in gains, Morgan Stanley analysts led by Adam Richmond wrote in a report on Friday. They funnel much of that money toward high-grade corporate debt, especially longer-dated bonds, to help fund their decades-long obligations.
That trend is already happening and could now intensify, according to Morgan Stanley analysts. U.S. company pension funds own more than $1.8 trillion of assets, and even small changes to their allocations can lift already-high prices for bonds, and weigh on stocks.
The biggest gainers may be corporate bonds maturing in around 30 years. Longer-term corporate bonds have risen 1.9% this year, including interest payments, compared with around 1.6% for the broader investment-grade universe, according to Bloomberg Barclays indexes.
“Pension funds’ sweet spot is out at the long end of the curve,” said Vincent Murray, who heads U.S. fixed income syndicate at Mizuho Securities USA in New York. Investors in some deals he’s worked on this year have placed orders for five times as much 30-year debt as was for sale, he said. “We’ve seen good demand.”
U.S. companies had overfunded pensions for most of the 1990s, but at the turn of the millennium lapsed into perennial underfunding as interest rates fell and stocks crashed. That trend may be reversing thanks in part to the surging U.S. equity market, which is up nearly 6 percent this year including dividends. Rising bond yields help as well, by lifting potential income from fixed-income investments and decreasing the accounting value of future obligations. As of March 31, the deficit for S&P 1500 companies was around $391 billion, compared with around $504 billion at the end of 2014, according to consulting firm Mercer.
Some companies are also putting more money into their pension plans as the U.S. government charges more to backstop plans with big deficits. 3M Co., United Parcel Service Inc. and Honeywell International Inc. and others increased their allocations to corporate bonds last year, according to a report from Goldman Sachs Group Inc.’s asset management unit.
With smaller deficits, many pensions automatically pile into less volatile securities to reduce the chances of their losing ground again. The pension plans at 50 of the biggest U.S. publicly traded companies have been boosting their allocations to bonds and reducing their stock holdings for at least two years, according to Goldman Sachs Asset Management. These pensions held 44% of their assets in bonds last year compared with 35% in equities.