Review

Corporate defined benefit plans saw declines in funding level during second-quarter 2019. A typical return-driven plan had a 3.1% decrease in its funded ratio, while a typical liability-driven plan had a 0.9% decrease. Liability-driven plans with higher allocations to longer duration assets tend to see smaller funded ratio movements when market volatility increases. According to our analysis, equity markets provided the only positive impact on the funded level, while interest rate declines and tightening credit spreads that increased liabilities had a negative impact.

Funded Ratio Change: Return-Driven Plan                              Funded Ratio Change: Liability-Driven Plan            

Source: PNC                                                                                      Source: PNC

Assumptions

  • The funded ratio changes displayed above are for generic plans with allocation and liability profiles specified below. Results are market driven and do not incorporate any plan-specific effects, such as benefit payments, expenses, benefit accruals, or plan contributions. Funded ratio changes are sensitive to the beginning of the period funded ratio.
  • A return-driven plan is a pension plan with an asset allocation commonly associated with an absolute return objective and has a high allocation to return-seeking assets (public equity in this case) and typically has high funded status volatility. Assumed asset allocation is 70% MSCI All Country World, 30% Barclays Aggregate.
  • A liability-driven plan is one that is well along its path in a liability-centric approach to investing and has a large allocation to long-duration bonds to help reduce funded status volatility. Assumed asset allocation is 30%MSCI All Country World, 56% Barclays Long Credit, and 14% Barclays Long Government.
  • The liability profile is based on BAML Mature/Average US Pension Plan AAA-A Corp Indexes with average duration of 15 years.

Treasury Rates

Treasury Curve

Source: BAML U.S. Treasury Curve

Treasury rates declined and lowered funded ratios as liabilities increased.

Treasury rates declined across the entire yield curve during the quarter, with the largest declines in below 10 years of maturity. The short end of the curve declined as much as 50 basis points (bps) while declines for longer maturities were closer to 30 bps. Interest rate movement during the quarter was driven by a dovish shift in major central banks globally, including the Federal Reserve (Fed) that is now eying possible rate cuts this year. Demand for Treasuries also increased during the May equity market correction.

Credit Spreads

Credit Spreads

Source: Barclays Live

Tightening credit spreads further lowered funded ratios as liabilities increased.

Credit spreads tightened during the quarter as investors pursued higher returns. Intermediate and long credit spreads narrowed 1 and 11 bps, respectively. Credit outperformed Treasuries during the quarter; generally, the lower the credit quality, the higher the returns for investment-grade bonds. On a net basis, the total corporate bond discount rate (derived from higher quality bonds) was down around 40 bps with only 6 bps attributed to corporate spread tightening.

Equities

Equity Index Total Returns

Source: Russell, MSCI

Strong equity markets helped improve plan funding levels.

Equities posted decent gains during the second quarter, continuing the positive performance from the first quarter. The quarter was a rocky one with a bullish April followed by declines in May and strong recovery in June. The Fed’s commentary was one of the major drivers of positive performance during the quarter. Declines in May were driven primarily by trade war concerns. Domestic large-cap stocks posted larger gains above 4% while emerging market stocks lagged, posting gains below 1%.

For more information, contact Kimberlene Matthews, Director of Pension Solutions, at 312-338-8138 or kimberlene.matthews@pnc.com.