Last week Ford (F) announced plans to shift their pension fund even more heavily towards bonds. At a time when interest rates are ruinously low and equities should appear attractively priced to a long-term investor such as a pension fund this represents quite a radical move. As recently as 2006 the company had targeted an equity allocation of 70%. Generally pension obligations are long-lived and one would expect pension funds to be more tolerant of equity market volatility in their quest for higher long-term returns. However, Ford’s stance probably reflects an acknowledgment of the inherent cyclicality in their own business; if they had a higher equity allocation in their pension fund, it would likely be most under-funded during a weak equity market which would coincide with a tough automobile market, perhaps stretching Ford’s ability to inject additional cash to meet a projected shortfall. It’s part of a plan to reduce the risk of their overall balance sheet. Nonetheless, the reaching the 7.5% return target (reduced from 8%) on their pension assets appears challenging with 80% of their assets in fixed income, and the company is currently facing a $15.4BN shortfall on such obligations. Today’s yield curve is a long way short of delivering adequate returns, even with the other 20% of their pension assets invested in “growth assets (primarily alternative investments, which include hedge funds, real estate, private equity, and public equity)”. Naturally I should point out that hedge funds may wind up underperforming even their fixed income allocation if past history is any guide.
But it does illustrate an alternative to the concept of overweighting equites to meet pension obligations. Ford is in effect relying on strong operating results to generate additional cash contributions (which will surely be needed). The decisions they’ve taken are consistent with an analysis showing that their business prospects will generally be tied to those of the overall economy and therefore public equities. So rather than invest directly in diversified equities that will (they assume) correlate with Ford’s own results, they are relying on their own equity-like business prospects to generate needed future cashflows. It’s quite a clever strategy. They reduce their balance sheet risk and the volatility of their pension obligations. The worst scenario is one where Ford’s results are dismal while the economy is doing well, perhaps driving up their ultimate obligations at a time when they’re ill-equipped to contribute more needed cash. But they may have calculated that retiring Ford workers will earn pension tied to their pre-retirement earnings, again mitigating their risk.
Ford’s approach represents an intriguing approach to the pension shortfall common to many S&P500 companies.
Read more posts on In Pursuit of Value »
