Stock portfolios at large pension funds had a blockbuster run. Now, managers are cashing out.
Corporate pension funds are shifting money into bonds. State and local government funds are swapping stocks for alternative investments. The nation’s largest public pension, the California Public Employees’ Retirement System, is planning to move close to $25 billion out of equities and into private equity and private debt.
Like investors of all kinds, the funds are slowly adapting to a world of yield, where they can get sizable returns on risk-free assets. That is rippling throughout markets, as investors assess how much risk they want to take on. Moving out of stocks could mean surrendering some potential gains. Hold too much, for too long, and prices might fall.
For pension funds, which target specific investment returns to fund future obligations, this is a welcome change: It means they can take less risk and stay on track toward those goals. They can sell stocks, lock in price gains and move the money into bonds without sacrificing too much return. Or they can continue to push for higher returns without taking on much more risk.
While stocks have slumped recently, the S&P 500 remains just 4.4% below its record close. The index’s 10% gain through the end of March marked its best first-quarter performance since 2019. Meanwhile, a persistently strong economy has pushed interest rates to multidecade highs.
The combination is leading large retirement funds to rotate their positions. Goldman Sachs analysts estimate that pensions will unload $325 billion in stocks this year, up from $191 billion in 2023.
“You don’t want to give away all of those hard-earned gains,” said Zorast Wadia, a principal and consulting actuary at Milliman. “You don’t want to give it back if stocks fall.”
Pension funds for workers at companies and state and local governments together held about $9 trillion at the end of 2023, according to Federal Reserve data. Many have been trying for years to come up with enough money to cover promised future benefits.
Big companies have mostly switched new hires to 401(k)-style retirement options, and have built up pension savings over the past two decades. Last year, they reported having enough to cover their liabilities for the first time since the 2008-09 financial crisis, Milliman found. As a result, corporate pension managers are investing less aggressively, with stocks making up less than one-quarter of investments.
State and local government pension plans mostly remain open to new workers and have around three-quarters of the money they need to cover future pension promises. They keep around half of their investments in stocks and more than 15% in other risky assets such as private equity, according to median figures from Wilshire Trust Universe Comparison Service.
The California Public Employees’ Retirement System board voted in March to reduce its target stock allocation to 37% from 42% while ramping up investment in private equity and private debt. The fund expects those two asset classes to return 7% to 8% over the next two decades, compared with 6% to 7% for stocks. The $494 billion fund had about 72% of assets needed to cover future pension promises as of June.
The $260 billion New York State Common Retirement Fund, which serves police, firefighters and other public workers, is almost fully funded. But officials still decided earlier this month to shift money into private equity, real estate and real assets after a change in state law increased the cap on private market investments. The fund is reducing its target stock allocation to 39% from 47%.
“The model projected very slightly higher return for very slightly lower risk” on the new asset mix, said director of asset allocation Michael Lombardi.
A different kind of state investment fund, the $80 billion Alaska Permanent Fund Corp., is cutting back on equity risk. The APFC invests mineral revenue and other state money and has no benefit payment obligations.
The fund is in the process of reducing its stock portfolio from 36% of assets in fiscal 2023 to 32% in 2025, and canceled a plan to lower bonds to 18% from 20%. Higher rates mean APFC can still expect enough income from bonds to meet its investment target, returning 5 percentage points more than the consumer-price index, said Marcus Frampton APFC’s investment chief. Stocks’ high prices relative to corporate earnings leave him concerned about losses.
Companies in the S&P 500 trade at around 24 times their past 12 months of earnings, above the five-year average of 22 times, according to FactSet.
“When it’s a very expensive stock market, bad things can happen,” Frampton said.
APFC’s reduction in stocks last year—and a decision to invest less money in shares of large, fast-growing companies—resulted in some missed gains in the fiscal year ended June 30, 2023. But APFC’s move helped free up enough money for the fund to keep around $350 million in gold exchange-traded funds. As of Wednesday, gold futures have gained 31% since October.
Corporate pension plans, too, are embracing higher rates as a chance to lower risk without sacrificing as much income.
These plans often assemble bond portfolios that will pay out as promised pensions come due. Over the past two decades, they have moved more money into those bond portfolios and out of stocks.
Johnson & Johnson, the pharmaceutical and medical technology company, dropped the target stock allocation for its $34 billion pension fund to 58% in 2023 from 62% in 2022. The company planned to put the additional money into bonds.
Aerospace and defense company RTX reported that public equity investment made up 19% of assets in 2023, down from 26% in 2022.
The move out of stocks bodes well for the long-term health of pension systems, said Timothy Braude, managing director and co-head of multiasset solutions at Goldman Sachs.
“It is very easy to say you want to take risk down at moments when you have no ability to actually do so,” he said.
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