The 30-year Bond

[HenryTo]

This is interesting - from the June 13th edition of Pensions & Investments (okay, I am behind in my reading).

The BCA has previously mentioned that if DB pension funds follow the Britain model, they will shift $500 billion to $600 billion of their monies from equities to bonds in order to better match their liabilities. I am guessing less - mainly because we have or will have better hedging tools when/if IAS 19 comes along next year. That being said, even half of that $500 billion number is nothing to sneeze at.

"Matching assets to liabilities is a move that many ERISA [Defined Benefits] funds have been examining - especially with the prospect of mark-to-market accounting become the norm - as longer-duration securities enable corporations to ensure pension obligation benefit payments over a longer period of time on their balance sheets.

"The Treasury will announce on Aug. 3 whether it will issue the 30-year bond for the first time since October 2001. Most observers expect the Treasury to issue $20 billion to $30 billion in bonds next February."

[Dubious]

U.S. Govt is in talks to start a R fund in their TSP.

R= REIT fund.

The party is about over for this cycle. IMHO.

[HenryTo]

Pete,

Many companies are now in the process of developing hedging instruments specifically for DB pension plans - such as an index tied to the S&P 500 but which sets a floor for their returns. Of course, given the relatively high valuation of the S&P 500 (relative to historic P/E ratios), one can argue that 7% to 8% is probably not achievable going forward, but it is probably better than a return specifically tied to bonds.

Other, "more sophisticated" pensions are investing in REITS, real estate, hedge funds, and commodities - although one can argue that everything is highly overvalued from a historical standpoint.

So I would agree with you here - any company that has a legacy DB pension plan here would probably see their earnings decimated if ROR assumptions get racheted down from their current levels down to 4% to 5%. Anyone who are REALLY INTERESTED in this should check out the companies' 10-Ks and and also read up on FAS 87 and FAS 132 accounting. Warning: It is really not too exciting of a job to do.

Henry

[pete richardson]

Henry --

Here's another interesting and related issue:

Over the 1985-2000 period, many DB plans raised the actuarial
rate of return assumption for their respective plans. With an
elevated ROR% backed by strong stock and bond market performance,
funding and pension expenses dropped off sharply.

Now, we have DB plans which need to latter maturities to assure
proper liability matching. But if pension officers opt to cover
oncoming liabilities securely, they may be using 4-5% Treasuries
to do so.

In such cases, the ROR% assumptions may definitely be too high.
This could mandate reducing ROR% assumptions, which in turn
might force up funding and pension expense, which in turn would
weigh on cash flows and earnings.

Investors who do their own research need to study candidate
company pension plans carefully as there could be onerous
hidden burdens within those plans. There may also be pluses, too
as overfunded plans have excess value now that the
time to ladder to pay the liabilities is at hand.

PR