December 31, 2014


The last quarter of 2014 proved to be a strong quarter for both domestic equities and fixed income. Similarly, the calendar year ended with double digit returns for the S&P 500 at 11.39%, and almost 6% returns for the Barclays Capital Aggregate Index. With the RL asset allocation model returning 8.44%, one would think that pensions had pretty solid year. However, long corporate bonds (as measured by the A to AAA rated RL PPA yield curve) had an even stronger year, finishing 2014 with a calendar year return of 19.09%. As go corporate bonds, so to go pension liabilities.


The difference in return of the RL asset allocation model and the RL PPA yield curve was –10.65%. For six calendar years in a row going back to January 1, 2009 and ending December 31, 2014, a traditional asset allocation model of equities and core bonds have provided positive absolute returns. Three of those years assets have outperformed liabilities, three of those years they have not. What has not changed is the year end funding ratios. On December 31, 2009 the RL PPA funding proxy for traditional asset allocations was 78%. On December 31, 2014, the RL PPA funding proxy for a plan with a traditional asset allocation was…78%.


At the end of 2013, Bloomberg conducted their annual survey of economists to predict where the 10- year Treasury yield would finish at the end 2014. The average 10-year yield projection based on this survey was 3.41 percent. The 10-year Treasury yield was 2.17% on December 31, 2014, and 3.0% on January 1, 2014. The tightening of 83 bps on the 10-year resulted in the return of the 10-year Treasury being 10.76%. Returns on the 30-year Treasury were 29.57% for 2014.


The new year brings with it a chance to both reflect back on the events that occurred in the past twelve months and to set intentions for the year ahead. For plan sponsors with a core fixed income duration or shorter, 2014 was a year that led to a give up of funding gains that has occurred annually since 2011. For plans that were longer in duration, the liability rally consisting of the third highest annual liability return dating back to 2001 was partially or fully hedged. While different results occurred, each type of plan sponsor is now trying to determine how to set their asset allocation for the year or quarter ahead.


The start of 2015 has not been pretty. As of the A/L Watch publication date of January 15, 2015, the S&P 500 is down –3.22% and the VIX is up 16.61%. The combination of the domestic equity markets, geopolitical events, oil prices spiraling down, and other macroeconomic factors are going to make the next round of quarterly more intense than prior meetings. Conversations related to either beginning, continuing, or increasing the allocation to hedging assets to reduce surplus volatility will be had. Plan sponsors across the board should continue to have these discussions, quantify their surplus volatility, and hedge this risk accordingly.