Macro

US Pensions to Invest Billions in Corporate Bonds Amid 103.7% Funding

US Pensions to Redirect Billions into Corporate Bonds as Funding Levels Hit 103.7% in June

By Max Weldon

7/11, 11:56 EDT
S&P 500
iShares 20+ Year Treasury Bond ETF
iShares 7-10 Year Treasury Bond ETF
Bank of America Corporation
Goldman Sachs Group, Inc.
JP Morgan Chase & Co.
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Key Takeaway

  • US corporate pension plans, now 103.7% funded, are poised to shift billions into investment-grade corporate bonds due to high stock market gains and bond yields.
  • Pension funds control over $3 trillion and their demand is driving down risk premiums on US corporate bonds, currently at 90 basis points.
  • The American Rescue Plan Act's $97 billion aid has stabilized many pensions, prompting a strategic shift towards lower-risk debt products like STRIPS and investment-grade bonds.

Pension Funds Shift to Corporate Bonds

US company pensions are poised to redirect billions of dollars into corporate credit, driven by recent stock-market gains and higher bond yields. According to the Milliman 100 Pension Funding Index, corporate pension plans had 103.7% of the funding needed to meet obligations as of June, the highest level since 2022. This metric has dipped below 100% only four times since March 2022. The S&P 500's 18% total return this year has significantly contributed to this flushness, prompting retirement-fund managers to move resources from higher-risk assets like equities into bonds.

James Martin, a US credit strategist at UBS, noted, “I would certainly expect more corporate bond buying from pension funds if these levels are upheld.” Pension funds, which control over $3 trillion, are already seeking out investment-grade corporate bonds to lock in current high yields for their long-term obligations. This demand is one reason why valuations for US corporate bonds remain high, despite the Federal Reserve's rapid rate hikes over the past two years. As of Tuesday, average investment-grade spreads were just 90 basis points, well below the 10-year average of 123 basis points.

Historical Context and Federal Aid

Historically, pension managers start shifting allocations from stocks to bonds once funding levels exceed 80%. However, the 2008 financial crisis and prolonged low-interest rates left many funds struggling. The American Rescue Plan Act of 2021 provided an estimated $97 billion to distressed multi-employer pension plans, aiding their recovery and allowing managers to refocus on long-term investments.

Daniel Sorid, Citi’s investment-grade credit strategist, explained, “Put yourself in the shoes of a pension-fund manager. Yesterday you were close to insolvency, but then once the federal government cuts a check, you’re more or less fully funded and all of a sudden your asset allocation needs to shift.” Sorid expects pension managers to start buying more corporate bonds soon, with the Pension Benefit Guaranty Corporation reviewing $13 billion in additional funding requests that could be paid out by August, potentially directing $2 billion into investment-grade debt.

Wall Street Banks and Corporate Debt Issuance

Wall Street’s largest banks are set to borrow more than usual after reporting second-quarter earnings, taking advantage of falling yields. JPMorgan Chase & Co. credit analyst Kabir Caprihan predicts the six biggest US banks could borrow $21 billion to $24 billion, higher than the decade average of $17 billion for July. This borrowing spree is likely to be met with strong demand from investors, including foreign firms and US pension plans.

Banks face about $50 billion in redemption calls and maturities in the second half of 2024, with Barclays analysts expecting these bonds to be fully replaced with new senior debt. Barclays forecasts $30 billion in borrowing for the third quarter, with Bank of America and Goldman Sachs expected to be significant issuers. Arnold Kakuda, a Bloomberg Intelligence analyst, anticipates big-bank bond issuance to rise due to new capital rules, predicting $20 billion to $25 billion in issuance this month.

Street Views

  • James Martin, UBS (Bullish on corporate bonds):

    "I would certainly expect more corporate bond buying from pension funds if these levels are upheld."

  • Mike Moran, Goldman Sachs Asset Management (Cautiously Optimistic on fixed income products for pensions):

    "This is a period of strength, a position of strength, for plan sponsors, and history shows us that the position of strength can sometimes be fleeting. So it’s important for plans to take actions."

  • Daniel Sorid, Citi (Neutral on current pension fund asset changes but optimistic about future demand):

    "Even if it doesn’t fully materialize, it always hangs out there as this potential new demand source and helps to support the market."