For Most Taft-Hartley Plans, Market-Based Returns on Their Own Will Likely Be Too Low over the Next Decade to Close the Asset-Liability Gap, Underscoring the Need for Greater Emphasis on Active Management, Private Investments and Governance
BOSTON (April 25, 2017) – Despite perceptions about current and future rates of labor union membership, many multi-employer pension plans, also referred to as Taft-Hartley or union-sponsored plans, remain a major force – and face significant challenges.
Approximately 1,400 multiemployer defined benefit plans – plans maintained by more than one employer along with a labor union – exist in the U.S., covering about 10.4 million participants. But their aggregate funded status – the percentage of future obligations that current assets cover – significantly lags that of single-employer pension plans when using similar metrics for comparison.
According to global investment firm Cambridge Associates, the solution to this problem may begin with multiemployer plan investment committees’ taking a new look at their decision-making processes, a step that, in turn, could lead them to potential investment opportunities that may deliver needed higher returns, perhaps in exchange for liquidity.
“Given our low-return, low-rate investment environment, it’s unlikely that a simple mixture of stocks and bonds will generate the 7% to 8% or even higher returns that multiemployer pension plans need – and that many trustees are counting on – in order to meet future funding requirements,” says Alex Pekker, Senior Investment Director at Cambridge Associates and author of “A Stronger Union,” a new Cambridge Associates Pension Series research report.
Multiemployer plans’ aggregate funded status, based on Aa corporate yields, the same basis corporate plans use to determine their funded status, is only 51%, according to estimates from Cambridge Associates. That is about 25% to 30% lower than the aggregate funded status of corporate plans.
“The good news is that there may be opportunities for a significant number of plans to reset their investment approaches. This may involve trading some portfolio liquidity for potentially greater returns, such as through select private investments. Also key may be recalibrating plans’ use of active management strategies, or even their investment decision-making policies and roles.” Pekker says.
Unique Challenges that Multiemployer Plans Face
The unique challenge for multiemployer plans stems from plan demographics, and the multiplicity of important priorities and constituents represented on the plans’ investment committees.
First, as baby boomers move into retirement age, disbursements from the plans correspondingly increase, in tandem with the rising number of retirees eligible for plan payouts. At the same time, declining union membership means lower contributions coming in to replenish plan assets. In addition, multiemployer pension investment committees are composed of disparate groups of people: representatives of different companies on the management side, each of which may have different priorities – and a mix of retirees and current workers on the union side, who tend to have very different objectives for the pension fund based on their age and working status.
Looking to Private Investments for Potentially Strong Returns
Going beyond stocks and bonds as portfolio investments may make a big difference for multiemployer plan trustees and participants. Carefully selected private investments, which include private equity, venture capital, real assets and private credit, could be an important component for many portfolios. For example, over the past 10, 15 and 20 years, global private equity funds have outperformed the global public equity markets by 480 basis points to 710 basis points, on an annualized basis. The challenge with private investments is that they are longer-term investments, and involve giving up some liquidity.
But some multiemployer plans may be more able to take advantage of the opportunity than they currently do. “Trustees often underestimate their plan’s tolerance for private investments, either by overestimating their liquidity needs or by mistakenly characterizing all private strategies as on the far end of the liquidity spectrum,” says Brian McDonnell, head of the global pension practice at Cambridge Associates.
It is important for plan sponsors to recognize that private investment options are more extensive than simply large private equity and venture capital funds. They come in the form of a wide range of funds, each with very different liquidity, growth, income and risk profiles, and include both private credit and equity instruments, as well as involvement in everything from early-stage start-ups to mature companies.
Private credit in particular may present interesting opportunities for multiemployer plans, due to the wide range of strategies and lock-up periods available. These strategies, for instance, can aim to maximize returns (e.g., investing in distressed corporate debt), preserve capital (e.g., direct lending to corporate borrowers) or both (e.g., investments in pharmaceutical royalties). Most private credit funds require a commitment of six to 12 years, in contrast to the typical 10-12 years of other private investments.
Considerations for Implementing Illiquid Investments
Careful manager selection is critical for finding private investment funds that will generate excess returns, or “alpha,” according to Pekker. And any plan’s investment decisions must be informed by its particular circumstances, including funded status, risk tolerance, liquidity and cash flow, and the objectives of its committee members and participating employees.
In fact, while private investments could play an important role in addressing the challenges faced by many union plans, they are not appropriate for all plans, nor are they the only solution.
“Finding alpha at both manager and portfolio levels, as well as diligent risk management, are fundamental to plan success,” says Pekker. “Whether that involves some elements of private investments or other approaches, however, should depend on each plan’s unique features, constraints and needs. Regardless, revisiting investment decision-making processes to ensure each decision is as well-thought-out, efficient and timely as possible will be critical to multiemployer plans’ future health and viability,” adds Pekker.
For more information, or to speak with Alex Pekker, please contact Eric Mosher of Sommerfield Communications at +1 (212) 255-8386 or firstname.lastname@example.org.
About Cambridge Associates
Cambridge Associates is a global investment firm founded in 1973 that builds customized investment portfolios for institutional investors and private clients around the world. Working alongside its early clients, among them several leading universities, the firm pioneered the strategy of high equity orientation and broad diversification, which since the 1980s has been a primary driver of performance for these leading fiduciary investors. Cambridge Associates serves over 1,100 global investors – primarily foundations and endowments, pensions and family offices – and delivers a range of services, including outsourced investment (OCIO) solutions, traditional advisory services, and access to research and tools across global asset classes. Cambridge Associates has more than 1,300 employees – including over 150 research staff – serving its client base globally. The firm maintains offices in Arlington, VA; New York; Boston; Dallas; Menlo Park and San Francisco, CA; Toronto; London, UK; Singapore; Sydney; and Beijing. Cambridge Associates consists of five global investment consulting affiliates that are all under common ownership and control. For more information about Cambridge Associates, please visit www.cambridgeassociates.com.