The funding gap, between what corporations owe in pension plan
obligations and their assets, narrowed by $72.4 billion last year as the U.S.
stock market rallied and companies from Boeing Co to Verizon Communications Inc
made multi-billion dollar contributions, according to a new study by
Seattle-based consultants, Milliman, Inc.
But as funding improves, pensions reduce their portfolio risk,
reallocating assets from equities into long-duration debt, driving up demand
for corporate bonds and 10- and 30-year U.S. Treasuries.
The likely sizeable shift in $1.55 trillion of pension fund assets may
raise bond prices enough to tamp down the long end of the yield curve, reducing
the difference between long and short term debt yields.
The move may have already begun. Demand from pension funds and insurance
companies “is part of the reason we have seen a fairly aggressive flattening of
the yield curve over the last six-12 months,” said Neil Sutherland, fixed
income portfolio manager at Schroders.
On Tuesday, the 10-year Treasury yield broke the psychologically
important yield level of 3.0 percent, but the curve remains significantly
flatter than it was at the start of 2018. The difference between U.S. 5-year
notes and the 30-year long bond yield for example was around 0.38 percentage
points on Wednesday, compared to 0.51 percentage points on Jan. 2.
There are a range of estimates about how much money exactly will be
going into fixed income. U.S. corporate pension plans could purchase around
$150 billion in high-quality, long-duration fixed income each year for the next
several, according to Michael Moran, chief pension strategist at Goldman Sachs
Asset Management.
More than half of the total return gains pension funds made in 2017
could be invested in the fixed-income market, said Louis Finney, executive
director of asset allocation on the Investment Solutions team at UBS Global
Asset Management. Last year, the ratio of funding to obligations at the 100
largest U.S. corporate pensions rose to 86 percent, a 5 percentage point jump
that is worth $72.4 billion, according to Milliman.
That means half of that, or $36.2 billion, could be put to work in
long-duration bonds.
Another factor that could boost demand for long-duration bond prices is
the $34 billion in contributions employers plan to make before September, after
which tax deductions will have to be taken at the new lower rate under the tax
reform law passed by the U.S. Congress last year.
Corporate bonds are pension funds’ first pick for fixed-income
investment, but low supply may drive them further into the U.S. Treasury
market. Around $165 billion of 30-year high-quality corporate bonds are issued
a year, according to Moran.
As U.S. companies with foreign earnings repatriate cash, after the tax
law changes last year, there may be less need to issue new corporate debt. With
pension demand averaging around $150 billion, “it could lead to a bit of a food
fight for these bonds,” Moran said.
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