Is the Fed Squeezing Pension Plans?

Last month, the Federal Reserve announced it would keep its target for the federal funds rate at “exceptionally low” levels at least through late 2014.  The Fed has maintained its zero interest rate policy since late 2008.  While the loose monetary policy is intended to boost the fragile economy, it is causing serious problems for pension plans.

The Fed’s ultra low interest rates are causing a growing concern for pension funds, as most pension plans were based on an average rate of return of 8 percent.  However, with the Fed pushing down interest rates, these rates are not achievable without taking a significant amount of additional risk.  “For most people, there’s been more downside to these low rates than upside,” says Barry Ritholtz, chief executive officer of FusionIQ, a New York-based investment research firm.

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According to a recent report from Credit Suisse (NYSE:CS), some of the nation’s largest companies owe their pension plans more than 25 percent of their market cap.  A staggering amount that could impact future earnings.  The companies on the list include: AK Steel (NYSE:AKS), Goodyear Tire (NYSE:GT), United States Steel (NYSE:X), Sears (NASDAQ:SHLD), Lockheed Martin (NYSE:LMT), Supervalu (NYSE:SVU), Whirlpool (NYSE:WHR), Ford (NYSE:F), Alcoa (NYSE:AA) and Raytheon (NYSE:RTN).  Bank of America (NYSE:BAC) recently downgraded AK Steel from Neutral to Underperform, because of the company’s pension liability.

In order to make up the difference for the low returns, it is estimated that companies would have to start earning nearly 20 percent on their investments.  According to consulting firm Aon Hewitt, pension funds have been trying to boost returns by buying bonds with longer dated maturities.  However, longer-dated bonds place more risk on pension plans, because when interest rates finally start to rise, bond values will fall.  Other companies such as Boeing (NYSE:BA) have added record amounts of cash contributions to their pension plans over the past year.  For 2012, the company will add an estimated $1.5 billion to its pension plan.

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“The traditional tools to manage a portfolio, like time horizon and diversification, have been thrown out the window,” says Jack A. Ablin, chief investment officer at Harris Private Bank in Chicago. “All the lessons my generation has learned over our lifetime have been seriously called into question these last few years.”

To contact the reporter on this story: Eric McWhinnie at staff.writers@wallstcheatsheet.com

To contact the editor responsible for this story: Damien Hoffman at editors@wallstcheatsheet.com