Asset allocation lessons in a tough market
Now probably isn't the time when most investors feel like plunking a lot more money into the stock market.
Not with a recession looming, stock volatility spiking and other worries on the horizon.
Yet one notable pension outfit is jumping into stocks in a big way while slashing its exposure to bonds. Its example may hold asset-allocation clues for the rest of us.
The Pension Benefit Guaranty Corp., which takes over failed corporate pension programs and manages the money on behalf of workers and retirees, recently announced it has adopted a new policy on its $55 billion portfolio.
The federal corporation used to invest just 15 to 25 percent of its assets in stocks, with the rest in bonds and other fixed-income instruments.
Now, it's earmarking 45 percent into stocks, 45 percent into bonds, and the remaining 10 percent into "alternative" investments such as real estate and private equity.
The PBGC realized that it was leaving money on the table, in terms of significantly lower returns, with its bond-heavy portfolio. The organization, which doesn't rely on taxpayer funding, lacks sufficient resources to honor all future commitments, though the new stance is expected to help.
The new policy, which will take several months to implement, "will better manage our invested assets," said PBGC Director Charles E. F. Millard in a statement. "Although it should generate higher returns, it also offers lower risk through broader diversification."
Specifically, PBGC analysts figure the organization now has a 57 percent likelihood of fully funding its obligations within 10 years, up from just 19 percent before.
While the announcement didn't garner widespread publicity, it provides lessons about the risk-reward tradeoffs for stocks and bonds.
One lesson is that stocks, even amid recent setbacks, remain one of the best ways to beat inflation over the long haul - something PBGC officers and most other pension experts recognize.
"Over the past five or six years since the last bear market, for example, equity returns have been wonderful, while alternative investments also have generated good results," said Michael Malone, an independent pension consultant at MJM 401k in Phoenix. "The PBGC recognizes they missed the boat on a lot of investment opportunities and that it's time to enter the 21st century."
Equally telling is the decision to trim bonds and other fixed-income investments. While the public generally considers bonds to be safe, that's not necessarily the case.
Since bond investors must wait for interest payments to arrive and for the eventual repayment of their principal years down the road, they're highly vulnerable to inflation. Unlike stocks, which benefit from rising dividends and corporate earnings, bond returns typically are fixed.
That's one drawback to loading up on bonds for the long haul. Another danger is many bonds have become so complex that investors really don't know what they own - a problem exposed by the credit crunch.
"The people who own these bonds are scared," said Gordon DuGan, president and CEO of financial firm W.P. Carey & Co., during a real estate conference hosted by Arizona State University. "They're not sure how the assets will perform."
DuGan was referring to mortgage backed securities, but anxiety also has risen for high-yield IOUs and even mainstream corporate bonds.
High-quality corporate bonds now yield a full two percentage points more than Treasurys of similar maturities - one of the widest gaps ever.
The high yields and correspondingly low prices for corporate bonds reflect unease. "Investors are betting even some good companies will default on their debt obligations," DuGan said.
The point here isn't to jettison all your bonds, which typically are much less volatile than stocks. Rather, it's smart to diversify among broad asset classes and subcategories such as foreign stocks, small stocks and high-yield bonds.
The credit crunch, coming as it did amid the real estate slump and heightened stock-market volatility, has demonstrated that there are no perfect investments out there.
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