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Contact:
Stephanie L. Poe
+1 202 331 5210 stephanie.poe@mercer.com
Barry McInerney
+1 212 345 7632 barry.mcinerney@mercer.com
Plan sponsors report minimal first-quarter results
Sponsors reflect on plan strategies in light of current capital market environment
New York, May 7, 2004
The median corporate, public, and foundation/endowment plan experienced low single-digit fund returns for the first quarter of 2004, finds a quarterly survey of plan sponsor performance by
Mercer Investment Consulting, Inc. (Mercer IC).
According to Mercer IC’s
Summary Performance of US Institutional Portfolios survey, the median corporate plan had a first-quarter gain of 3.1%. Both public plans and foundation/endowment funds had gains of 3.4%.
On a one-year basis, corporate plans had average gains of 28.8%, while public plans and foundation/endowment plans earned 30.8% and 29.4%, respectively. Over a 10-year time frame, all three plan types have averaged between 9.8% and 10.7% on an annualized basis.
Pension plan trends
“With future returns for equity and fixed income asset classes forecast to be lower, plan sponsors are re-evaluating their asset allocation strategies in order to maintain the delicate balance between achieving growth and minimizing risk,” says Barry McInerney, who leads Mercer IC in the US. The current return environment, coupled with the continued decline in interest rates during the first quarter, has put further pressure on plan funding levels, he adds, “although if the increase in long-term interest rates that has occurred early in the second quarter holds, this will supply some relief.”

Plan sponsors report minimal first-quarter results
Sponsors reflect on plan strategies in light of current capital market environment
May 7, 2004
Some plan sponsors may seek relief from funding pressures through a potential increase in the
Federal Reserve’s interest rate policy, Mr. McInerney says, but the adoption of a passive approach to plan management carries many risks. “While an increase in the Federal Funds rate will drive up short-term interest rates, the impact on longer-term rates used to value liabilities for funding purposes is uncertain, and therefore may offer sponsors little or no funding relief.”
Mr. McInerney points out that in adapting to the current capital markets environment, plan sponsors are focusing on strategies to reach conflicting goals: to better match assets to the plan’s underlying liability stream while also providing growth opportunities. Recent asset-allocation trends have shown that sponsors have begun to alter their base asset-allocation policies, he says, although the shift in policy varies depending upon the plan type (i.e., corporate, public, foundation/endowment).
In order to increase the correlation of assets to liabilities, sponsors are reviewing fixed income strategies such as long-duration and Treasury inflation-protected securities. This is because the typical duration of pension plan liabilities is well into the double digits (versus the duration of the Lehman Aggregate Bond Index of 4 to 5), and because of the inflation sensitivity of those pension liabilities that rise with participant salaries. “The adoption of this type of strategy requires a plan sponsor to adjust their definition of success by focusing on meeting liability-led objectives, not just asset-only objectives,” says Mr. McInerney. “While a rise in interest rates may negatively impact the strategy, evaluating performance within an asset-only context ignores the benefits of a strong asset-liability linkage in the form of reduced volatility in the funding ratio.”
On the equity side, sponsors are looking at a variety of alternative investment strategies that offer potential higher expected returns than traditional asset classes (such as pure global equity mandates, portable alpha strategies, and market-neutral and long/short mandates). The objective is to structure both traditional and alternative investments to work in tandem to produce a level of return in excess of traditional-only investments, but maintain an appropriate level of risk.
While many plans have typically shied away from alternatives due to their complexity, liquidity, and fiduciary concerns, sponsors are taking a fresh look at these alternative investments.
“There is a sea change within the industry caused by the ‘perfect storm’ of 2000–2002, which highlighted the vulnerability of plans to negative shocks within the capital markets structure,”
Mr. McInerney notes. Sponsors are taking a hard look at their current investment strategies, both from an asset allocation and a manager structure perspective, to determine the extent of changes necessary not only to avoid future “perfect storms,” but to manage assets in a lower-return environment. “As with any pronounced change, sponsors are moving slowly but steadily, while keeping in mind their fundamental fiduciary responsibilities,” adds Mr. McInerney.”
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Plan sponsors report minimal first-quarter results
Sponsors reflect on plan strategies in light of current capital market environment
May 7, 2004
Equity performance
According to Mercer IC’s analysis, both value and growth managers produced positive firstquarter results, with value managers outperforming their growth-oriented counterparts by 150 basis points. Based on Mercer’s Fearless Forecast , an annual survey of investment managers regarding their 2004 capital market expectations, large-cap equities are forecast to return 9.1% for the year, as the asset class is off to a slow start to the year. The small-cap asset class returned
6.3% for the quarter, a strong start versus a forecast of 8.7%.
The median large-cap manager outperformed the S&P 500 Index for the first quarter by 40 basis points, and outperformed the index by 70 basis points on an annualized basis over the last 10 years. Small-cap managers continued to outperform their large-cap counterparts, surpassing them by 400 basis points over the current quarter; the median small-cap manager returned 6.1% and the median large-cap manager returned 2.1%.
Within style mandates, value managers (both large-cap and small-cap) continued to outperform their growth counterparts during the first quarter. “Sponsors need to consistently review their balance between style mandates to avoid passively overweighting one style versus another due to capital market changes. Asset-allocation strategies can become susceptible to quick reversals in market sentiment if regular re-balancing strategies are not undertaken,” Mr. McInerney says.
The international equity asset class, with a return of 4.4%, outperformed its US large-cap counterpart for the quarter by a margin of 270 basis points, and outperformed US large-cap equities over the recent 12-month period by 23.0%. Currency was a neutral factor for the quarter as the positive returns from the asset class were driven by strong return in local markets. Within the international asset class, the value style outperformed growth by 170 basis points for the quarter and by 990 basis points for the 12-month period. Based on Mercer’s annual Fearless
Forecast , international equities are expected to earn 9.6% for 2004, yet the asset class returned
4.4% for the first quarter.
Fixed income performance
Within the fixed income asset class, the median core fixed income manager equaled the index in the first quarter and exceeded the index over a 12-month horizon by 70 basis points. Over a 10year period, the median manager has outperformed the index by 20 basis points.
Mercer’s 2004 Fearless Forecast predicted an annual return of only 2.5% for the core fixed income asset class. Yet the asset class returned 2.7% for the quarter, although investors are concerned about potential increases in interest rates.
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Plan sponsors report minimal first-quarter results
Sponsors reflect on plan strategies in light of current capital market environment
May 7, 2004
Core opportunistic managers equaled the performance of the index but out-performed the index by 200 basis points over the last year. The median high-yield manager had a positive gain of
2.2% for the quarter, and equaled the benchmark over the last quarter.
In assessing international fixed income performance, the median manager had a return of 1.9% for both non-US and global mandates. Both mandates produced solid 10-year results, 6.7% and
7.0%, respectively.
“The fixed income asset class continues to offer sponsors the stability they require in a volatile market even with the prospect of rising interest rates. The greater challenge for sponsors is to understand that while the fixed income allocation acts as a stabilizing force, the mismatch between asset and liability duration is a source of risk that caught many sponsors unaware,” according to Mr. McInerney.
About the survey
Summary Performance of US Institutional Portfolios is published quarterly by Mercer
Investment Consulting, Inc. The survey is intended to provide marketplace participants with summarized performance data for the most recent quarter and historical periods. Summarized information is shown for plan sponsors at the total plan level while manager performance data are provided at the asset class and sub-asset class level. Fund universes are courtesy of
Russell/Mellon Analytical Services. Manager universes are courtesy of Mercer’s proprietary manager database.
Summary Performance of US Institutional Portfolios may be downloaded free of charge from www.mercerIC.us
. Please note: All performance is measured in US dollars, before investment management fees are deducted. Mercer’s 2004 Fearless Forecast also may be downloaded from the site at no charge.
Mercer Investment Consulting is a leading global provider of investment consulting services, and offers customized guidance at every stage of the investment decision, risk management, and investment monitoring process. We have been dedicated to meeting the needs of clients for more than 30 years, and work with the fiduciaries of pension funds, foundations, endowments, and other investors in some 35 countries.
Throughout most of the world, Mercer Investment Consulting is an autonomous unit within
Mercer Human Resource Consulting LLC, a wholly owned subsidiary of Mercer Inc., a wholly owned subsidiary of Marsh & McLennan Companies, Inc. (MMC). MMC lists its stock (ticker symbol: MMC) on the New York, Chicago, Pacific, and London stock exchanges. In the US, the investment consulting practice is operated through Mercer Investment Consulting, Inc., a wholly owned subsidiary of Mercer Human Resource Consulting, Inc., the US operating unit of Mercer
Human Resource Consulting LLC.
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Plan sponsors report minimal first-quarter results
Sponsors reflect on plan strategies in light of current capital market environment
May 7, 2004
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