Rethinking Pension Fund Investment Strategies

Abstract

This paper addresses the need for companies to reexamine their pension fund investment strategies because of certain changes that occurred during the 1980s that enhanced the attractiveness of fixed-income securities. Of primary importance was the issuance of a new pension accounting standard that substantially changed the determination of annual pension expense, pension plan asset and liability recognition, and pension footnote disclosures. Both the concepts and the information resulting from the pension standard have promoted a more integrative perspective of the relationship between pension funds and their corporate sponsors. This broadened perception of companies and their pension funds comprising a single economic entity has important financial consequences for corporate managements and capital providers. One such consequence pertains to pension portfolios. Fixed-income securities become a more desirable pension fund investment for two principal reasons: they reduce financial reporting risk without increasing economic risk and they are an integral component of corporate tax arbitrage, a strategy initially proposed by Fischer Black in the early 1980s.

Accounting Recognition and the Determinants of Pension Asset Allocation

“…Managers can actually avoid the recognition of additional minimum liability by choosing a different mix of stocks and bonds (Bodie [1990]; Brownlee and Marshall [1994]). In particular, firms that invest in bonds have a high correlation between the pension assets and obligations, which reduces the likelihood of facing a pension deficit.…”