Asset allocations in defined benefit (DB) plans strongly affect overall investment returns, the plan’s funded status and funding volatility, as well as the sponsor’s cash cost and accounting expense over time. For participants, creditors, investors and regulators, asset allocations are central to a plan’s risk exposure and long-term cost. The Financial Accounting Standards Board began requiring more detailed disclosures in 2009, and Towers Watson has been analyzing asset allocations ever since.1 These analyses track asset allocation trends and patterns over time. 

This fifth analysis looks at fiscal year-end 2013 pension allocations by asset class and valuation level. To enable investors and others to assess the way fair value is measured, companies must disclose a valuation level for each major asset category:

  • Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities

    (typical for Treasury securities and the common stock of large U.S. companies)

  • Level 2: Unadjusted quoted prices for similar assets in active or inactive markets, or

    other observable inputs (common for corporate debt)

  • Level 3: Unobservable inputs supported by little or no market activity, such as an expert appraisal of a real estate holding2

The analysis is performed on both an aggregate- and average-sponsor basis as well as by plan size, plan status (active, frozen or closed) and funded status. We compare asset holdings from 2009 through 2013 for a consistent sample of sponsors. Finally, we examine the prevalence and amount of pension assets invested in company securities.

Analysis highlights

  • Frozen pension plans invested almost half their total assets in conservative, lower-variance investment instruments, such as cash and debt, whereas sponsors of plans where some or all workers continued to accrue benefits (open and closed plans) seemed more inclined to take on riskier investments.
  • Robust equity returns coupled with plan contributions boosted some equity-heavy plans into a funding surplus by year-end 2013. Conversely, bond returns were weaker in 2013, so funding levels in plans with higher debt allocations generally either held steady or rose slightly. 
  • In 2013, 11% of these DB plan sponsors held assets in the form of company securities, and the allocations averaged 4.5% of pension assets.
  • Large equity allocations paid off in 2013, but weaker equity returns thus far in 2014 and falling interest rates could negate those 2013 funding gains.

2013 pension asset allocations

Towers Watson’s analysis of 2013 fiscal year-end asset allocations takes a detailed look at 544 Fortune 1000 U.S. pension plan sponsors’ disclosures. Figure 1 summarizes aggregate asset allocations weighted by plan size (as measured by the value of plan assets) and represents how the total dollars in all Fortune 1000 pensions are allocated. As of year-end 2013, these companies held more than $1.8 trillion in pension assets, composed of cash, public equity, debt, real estate, private equity, hedge funds (alternative investments) and other.

Figure 1. Aggregate asset distribution by class and level, 2013 ($ thousands)
Figure 1. Aggregate asset distribution by class and level, 2013 ($ thousands

*Cash includes cash equivalents and money market instruments.
**Debt includes insurance contracts.
***Hedge fund assets include derivatives and interest rate swaps.
****Values are less than 0.1%.
N=544

Source: Towers Watson

At year-end 2013, 42% of these pension assets were allocated to public equity, and 39.4% were allocated to debt, with the remaining investments spread among other nontraditional asset holdings.

More than half the asset valuations (55.5%) were done at Level 2, and 31.9% were done at Level 1. At 12.6%, Level 3 valuations, which are often used for private equity, hedge funds and real estate, were also significant.

Figure 2 depicts average asset allocations (not weighted by plan assets) for the same companies. The average Fortune 1000 pension plan in the analysis held assets worth more than $3 billion in 2013.

Figure 2. Average asset distribution by class and level, 2013 ($ thousands)
Figure 2. Average asset distribution by class and level, 2013 ($ thousands)

*Cash includes cash equivalents and money market instruments.
**Debt includes insurance contracts.
***Hedge fund assets include derivatives, insurance contracts and interest rate swaps.
****Values are less than 0.1%.
N=544

Source: Towers Watson

The average pension allocation to public equity was 47.4%, while the aggregate allocation was 42%. The difference between the aggregate and the average reflects differences in plan size — larger plans were less likely than smaller plans to invest in public equity. As for alternative investments — real estate, private equity, hedge funds and other investments — average allocations were 9.3% while aggregate allocations were 15.2%.

On average, less asset valuation was done at Level 3 — only 7.5% — and more at Level 1 — 36.2%. 

Pension asset allocations by plan size

Asset allocations for small, medium and large plans are shown in Figures 3a and 3b. The analysis divides these plans into three equal groups by asset values: Small plans held less than $454 million, midsize plans held between $454 million and $1.91 billion, and large plans held $1.92 billion or more. The largest plan held assets worth $93 billion.

Figure 3a. Aggregate asset allocations by plan size, 2013 ($ thousands)
Figure 3a. Aggregate asset allocations by plan size, 2013 ($ thousands)

Figure 3b. Average asset allocations by plan size, 2013 ($ thousands)
Figure 3b. Average asset allocations by plan size, 2013 ($ thousands)

*Cash includes cash equivalents and money market instruments.
**Debt includes insurance contracts.
***Hedge fund assets include derivatives and interest rate swaps.

Source: Towers Watson

Weighting small, medium and large plans by plan assets emphasizes the large share of pension assets held by very large plans,3 as well as the pronounced differences in investing behavior between small and very large plans (Figure 3a).

As plan size increased, public equity allocations declined, averaging 45.5% for the largest plans versus 50.2% for the smallest (Figure 3b). This confirms the differences between the results shown in Figures 1 and 2, where public equity holdings were lower when assets were weighted by plan size. While larger plans allocated less to public equities, they allocated more than small and midsize plans to other return-seeking investments, such as real estate, private equity and hedge funds.

Pension asset allocations by plan status

For this part of the analysis, we divided plan sponsors into three mutually exclusive categories: those whose primary pension plan was closed, those whose primary pension plan was frozen and those with active plans. Of the 544 companies in this study, 67% had either closed or frozen a pension plan, while 33% maintained active pension plans.

Figures 4a and 4b show asset allocations by plan status and demonstrate a relationship between plan status and investment risk, with the correlation strongest on an aggregate basis (Figure 4a). Frozen plans invested almost half their total assets in conservative, lower-variance investment instruments, such as cash and debt, whereas sponsors of plans where some or all workers continued to accrue benefits (open and closed plans) seemed more inclined to take on riskier investments.

Figure 4a. Aggregate asset allocations by plan status, 2013
Figure 4a. Aggregate asset allocations by plan status, 2013

Figure 4b. Average asset allocations by plan status, 2013
Figure 4b. Average asset allocations by plan status, 2013

*Cash includes cash equivalents and money market instruments.
**Debt includes insurance contracts.
***Hedge fund assets include derivatives and interest rate swaps.

Source: Towers Watson

Pension asset allocations by funded status

Figures 5a and 5b show 2012 and 2013 asset allocations by funded status.4 Between this and the prior study, the number of pensions that were fully funded rose from 4% to 14%. This funding improvement was due to strong equity returns (Figure 6), which particularly benefited plans with large equity holdings, and higher interest rates, which mitigated growth in pension obligations.

In our 2009 through 2012 analyses of asset allocations, pension funding was relatively stable, with average funded status typically ranging between 75% and 80%. Our 2012 analysis noted a correlation between funded status and asset allocations (Figure 5a). Companies with better-funded pensions held less in public equities and more in debt than their less well-funded counterparts, possibly reflecting an emphasis on volatility management.

In 2013, funded status rose significantly for pensions that were heavily invested in stocks, thus diminishing the relationship between funded status and asset allocations that existed in 2012 (Figure 5b). Instead, in 2013, sponsors of plans that were either less than 70% funded or fully funded seemed to be relatively more aggressive investors, generally allocating more to public equities compared with companies with funding levels between 70% and 99%.

Figure 5a. Average asset allocations by plan funded status, 2012
Figure 5a. Average asset allocations by plan funded status, 2012

Figure 5b. Average asset allocations by plan funded status, 2013
Figure 5b. Average asset allocations by plan funded status, 2013

*Cash includes cash equivalents and money market instruments.
**Debt includes insurance contracts.
***Hedge fund assets include derivatives and interest rate swaps.

Source: Towers Watson

Robust equity returns in 2013, as shown in Figure 6, coupled with plan contributions boosted many equity-heavy plans into a funding surplus by year-end 2013. Conversely, bond returns were weaker in 2013, so funding in plans with higher debt allocations generally either held steady or rose slightly.

Figure 6. Investment returns, 2009 – 2013
Figure 6. Investment returns, 2009 – 2013 

Source: Towers Watson

Larger increases in funded status go hand in hand with higher allocations to equities, while smaller increases are linked to higher allocations to debt (Figures 7a and 7b). Among plans with 70% or more of assets invested in equities at year-end 2013, funded status climbed by an average 23%. Among plans with less than 20% of assets in equities, funded status rose by only 7%.

Figure 7a. Equity allocations and funded status, 2012 – 2013
Click Image to Enlarge
Figure 7a. Equity allocations and funded status, 2012 – 2013

Figure 7b. Debt allocations and funded status, 2012 – 2013
Click Image to Enlarge
Figure 7b. Debt allocations and funded status, 2012 – 2013

Source: Towers Watson

Large equity allocations can help reduce pension costs over time, but the trade-off is higher risk and potential volatility. Large equity allocations paid off in 2013, but if stock returns are weaker in 2014 and interest rates continue falling, sponsors could lose their 2013 funding gains. Sponsors with high debt allocations have positioned their assets to move with their liabilities. While interest rates are falling this year, long bond returns have realized positive gains. Sponsors that have hedged their liabilities in this way should be protected from funding losses in 2014.

Although higher funded status in 2013 did not significantly change sponsors’ asset allocations (at least not by year-end 2013), it may be a trigger for pension de-risking for some. To reduce pension investment risk, sponsors could set future target allocations contingent on the plan’s funded status, which is often called a glide path strategy. Such a strategy shifts assets from equities to debt as funding levels improve, thereby reducing risk and safeguarding gains (albeit reducing opportunity for future gains as well).

Only 6% of the Fortune 1000 DB plan sponsors in this analysis explicitly stated in their annual pension disclosure that their future target allocations will depend on the plan’s funded status.

Pension assets held in company securities

In both 2012 and 2013, 11% of these DB plan sponsors held assets in the form of company securities. These allocations averaged 4.5% of pension assets in 2013, dropping to 2.2% when weighted by end-of-year assets. The weighted average is lower than the simple average because larger plans allocated lower percentages to company securities than smaller plans.

Of the 59 sponsors that held company securities in 2013, only two explicitly mentioned contributions of company securities on their pension disclosures.

In most of these plans, employer securities made up 4% or less of pension assets for 2013 (Figure 8). Company securities were more than 10% of plan assets in only a handful of companies, and those instances likely reflect higher returns rather than higher allocations to employer securities.5 In this analysis, the highest percentage of company securities as a share of plan assets was roughly 15%.

Figure 8. Allocations of company stock with positive holdings, 2013
Towers Watson Media

N=59

Source: Towers Watson

Five-year asset allocations

The 2009 to 2013 asset allocation studies are based on a consistent sample of 316 companies. Figures 9a and 9b show asset allocations for these companies on an aggregate and average basis over those five years. Overall asset allocations were relatively stable in 2009 and 2010, but between 2010 and 2011 — a period of poor stock market performance — average allocations to equity dropped from 51.1% to 46.4%, while average allocations to debt rose from 35% to 38.8%.

There was little change in overall asset allocations between 2011 and 2012. Between 2012 and 2013, equity allocations rose and debt allocations declined, but both changes were relatively small. The 2013 increase in equities is likely because outsize returns increased the equity share of the portfolio, rather than the result of a choice to allocate more to equities.

Figure 9a. Aggregate asset allocations by class and level for consistent sample, 2009 – 2013 ($ thousands)
Click Image to Enlarge
Figure 9a. Aggregate asset allocations by class and level for consistent sample, 2009 – 2013 ($ thousands)

 

Figure 9b. Average asset allocation by class and level for consistent sample, 2009 – 2013 ($ thousands)
Click Image to Enlarge
Figure 9b. Average asset allocation by class and level for consistent sample, 2009 – 2013 ($ thousands)

*Cash includes cash equivalents and money market instruments.
**Debt includes insurance contracts.
***Hedge fund assets include derivatives and interest rate swaps.
****Values are less than 0.1%.
N=316

Source: Towers Watson

Conclusion

In 2013, the gradual shift from equities to debt ended, and asset allocations remained fairly constant. Larger plans continued to hold less equity than smaller plans and their allocations were more diversified. Frozen plans held more fixed-income assets, on average, compared with closed or open plans.

While pension de-risking has become increasingly important to some plan sponsors, the trend toward more conservative allocations seems to have stalled in 2013. Plan sponsors with substantial equity holdings appeared to ride the wave of strong equity returns and were rewarded with large gains. Previous analyses noted a strong correlation between conservative asset holdings and well-funded pension plans. This was not the case at year-end 2013, as many sponsors who ended the year with well-funded pensions had benefited from strong equity returns.

Thus far in 2014, equity markets have not been as strong as in 2013, and falling interest rates have increased pension obligations. Moreover, the potential release of updated mortality tables reflecting longevity improvements could drive obligations even higher, possibly by 6% to 8% for some companies, thus pushing funding ratios even lower by the end of 2014


Endnotes

1. See “2012 Asset Allocations in Fortune 1000 Pension Plans,” Towers Watson Insider, November 2013.

2. For Level 3 assets, a reconciliation of the beginning and ending balances is also required, reflecting the actual return on plan assets, purchases, sales and settlements.

3. For the largest plans ($1.92B – $93B), when looking at plan asset size in deciles, the 10th decile (or 18 largest plans) represents 38% of all plan assets in this study and 44% of assets among the largest group of DB plan sponsors.

4. Figure 5a is derived from last year’s analysis. Funded status is the ratio of the fair value of assets over projected benefit obligations at year-end.

5. To promote asset diversification, the Employee Retirement Income Security Act does not allow U.S. DB plans to invest more than 10% of assets in company securities.