Important Change in Pension Fund Management

I believe the following article published by the WSJ this evening reflects a monumental change in finance that perhaps comes only several times a century:

Browning, E.S., 2010. Pension funds flee stocks in search of less risky bets. The Wall Street Journal, Oct. 18.

The article chronicles a massive shift by pension funds from equity to bond investing. The negative performance of the US stock market from 2000 - 2010 is the cause for the shift along with a desire for less risky investments. The article states that pension fund managers have overlooked risk in making investment decisions, an incredible admission!

From the article:

"Corporate plans saw the value of the stocks they held at the market peak in October 2007 decline by about $1 trillion through early March 2009, according to the Center for Retirement Research."

This decline represents almost 2% of the entire wealth of the United States!

Of course since Mar. 2009 stocks have rebounded, however, the outlook is highly uncertain as revenue for many corporations is flat and profits have perhaps peaked. Some analysts do not forecast any significant increase for corporate profits through 2011.

Further, the implications in terms of a shift of capital are significant:

"The amounts at stake are large. Even though U.S. companies have long been reducing their use of pension plans, corporate pension funds still manage more than $2 trillion."

"A multiyear shift of nearly half of that sum to other kinds of investments is under way, according to McKinsey & Co. This would mean a movement of nearly $1 trillion to bonds and to alternatives such as hedge funds, private investment pools, annuities, derivatives and insurance plans." italics added

Both 401k and pension funds are abandoning equity investing, leaving the market in the hands of high frequency traders (a negative development in my view).

While the WSJ article does a good job of identifying this important trend in finance, it overlooks one issue.

The move from equity to bonds is influenced by the large US government deficit and the corresponding need for public financing. This creates a new supply of debt in the marketplace and appears to be at least partially responsible for the shift by pension funds to the purchase of bonds. Essentially the government financing operation is crowding out equity investment.

I view this as a disturbing trend as it limits the ability of industry to grow and to create jobs.

Capital flows often change and the situation could turn in favor of equities. However, under the best of scenarios, such a shift could take years.

The financial structure of America and business is changing!