Key themes for U.S. corporate pension plans in 2021

Mar 5, 2021

Be nimble and respond when opportunity knocks

In our investment themes for 2020, revised after the Covid-19 pandemic took hold, we put forward a series of recommendations for plan sponsors in dealing with decreasing contributions, rethinking the balance of credit and treasuries, and instituting best practices in rebalancing and managing liquidity. Acting on any of these ideas, however, required an ability to be nimble and respond when opportunity knocked. In 2021, sponsors should position themselves to move even more quickly to capitalize on four key themes:

Lock in funded ratio gains
We expect funded ratios to continue to improve in 2021. Sponsors should be monitoring their portfolios in real-time and be prepared to de-risk as opportunities arise.
Ready for inflation
Notwithstanding emerging inflationary pressures, plans should still seek to hedge the majority of their interest rate risk.
Allocate to rate-sensitive growth assets
Not all diversifying growth assets are created equal. We prefer growth assets that have interest rate sensitive characteristics similar to those of pension liabilities.
Seize the sustainability opportunity
There is an increasing body of research suggesting that ESG-friendly portfolios could be more resilient in downturns, consistent with the risk management goals of pensions.

Lock in funded ratio gains

Having the technology to monitor risks at the whole portfolio level and pivot in real time to take advantage of opportunities and lock in funded ratio gains continues to be critical for success.

In 2020, one clear period of elevated risk occurred during the initial uncertainty around Covid-19 lockdowns. Plans with the ability to analyze their surplus risk exposures by risk factor, for example the risk contribution of ‘rates’, ‘spreads’, ‘equity’ and other exposures, were able to understand how funded ratios were likely to behave and respond more quickly. The plans that did best had higher allocations to extended duration treasuries heading into the crisis, then were able to strategically or tactically shift into risk assets such as investment grade credit, high yield and emerging market debt (EMD) for the remainder of the year.1

Average funded ratio up 2.7% in 2020 (not including contributions)

As of December 31, 2020, average funded ratios for corporate plans are now approximately 2.7 percentage points above where they started the year according to BlackRock’s U.S. Pension Funding Update. If the pro-risk and reflationary view discussed in our 2021 global outlook comes to pass, we expect funded ratios to continue to improve. Sponsors should be monitoring their portfolios regularly using technology like we described above and should be prepared to de-risk as the opportunities arise. New tools such as fixed income ETFs can help reduce transaction costs and improve liquidity and are a strong complement to existing capital efficient liability driven investment (LDI) instruments that help lock in funded ratio gains as they occur.

Ready for inflation

One of the key themes of BlackRock’s 2021 global investment outlook is ‘the new nominal,’ in which inflationary pressures are set to emerge over the next five years. This is of interest for defined benefit (DB) plans where extended duration nominal bonds have long formed a key component of overall asset allocation and have helped preserve funded ratio volatility.

We believe the current data supports the decision to strategically stay the course in LDI programs. Although yields have risen at the longer end of the curve, the exhibit “A potentially higher inflation regime” below shows that the decline in real yields has offset much of the recent inflationary pressure on nominal bonds. The exhibit “Correlation of treasuries vs. equities remains low” also shows that treasuries have diversifying qualities versus equities and, most importantly, tend to become more negatively correlated in times of severe equity market dislocation – precisely the times at which DB plans need to preserve funded ratios.

De-risking in a low interest rate environment

A potentially higher inflation regime

Breakdown of 10-year U.S. treasury yield

Breakdown of 10-year U.S. treasury yield

Source: BlackRock with data from RefinitivDatastream as of January 8, 2021. Notes: The chart shows the breakdown of the 10-year U.S. Treasury yield, where the Inflation Breakeven is the 10-year nominal U.S. Treasury Yield minus the 10-year U.S. TIPS Yield.

Correlation of treasuries vs equities remains low

Correlation between S&P 500 return and 10-year U.S. treasury return

Correlation between S&P 500 return and 10-year U.S. treasury return

Source: Source: BlackRock with data from RefinitivDatastream as of January 8, 2021. Notes: The chart shows the correlation of daily 10-year U.S. Treasury yield returns and S&P500 returns over a rolling 90-day period.

Allocate to rate-sensitive growth assets

Growth assets are largely used by plans to close funding gaps, but they also have a role to play in preserving funded ratio levels and reducing risk. We continue to believe that not all diversifying growth assets are created equal when considered in liability-relative terms.

We prefer growth assets that have interest rate sensitive characteristics similar to those of pension liabilities, such as real estate, high yield, emerging market debt, and infrastructure.

Quotation start

We know that climate risk is investment risk. But we also believe the climate transition presents a historic investment opportunity.

Quotation end
Larry Fink 2021 Letter to CEOs

Seize the sustainability opportunity

There is an increasing body of research indicating that environmental, social and governance (ESG) has much in common with existing quality metrics such as strong balance sheets, suggesting that ESG-friendly portfolios could be more resilient in downturns, which would be helpful in preserving funded ratios.

Another interesting angle of sustainable investing that may directly affect corporate plans is the emergence of ‘green bonds’ – bonds that are issued exclusively to finance sustainable projects. While the market for corporate green bonds is small compared to the broad corporate bond market, it has grown quickly in the U.S. over the past two years. This has implications for asset portfolios in that it increases the potential investable universe for alpha and portfolio resilience. On the liability side, sponsors may need to consider how actuaries are incorporating green bonds into discount curves, which would have direct implications on how the credit piece of LDI programs is constructed for hedging purposes.

Download the full report of key themes for corporate pensions
We share our views on the issues that corporate pensions should focus on in 2021, including positioning themselves to more quickly preserve funded ratios, lock in gains, and respond to emerging trends in the market such as inflation and ESG.
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Martin Jaugietis, CFA
Co-head of Americas Pensions within Multi-Asset Strategies and Solutions team
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