Session Sponsor 1
$US Billions 7000 Total Corporate 6000 Government Union 5000 4000 3000 Growth in Total Pension Assets 2000 ERISA Enacted Start of 401k Plans 1000 0 71 76 81 86 91 96 01 2
Net Change In Pension Assets: 1971-2001, $US Billions 1971 2001 Net Change Corporate 80 3,370 4,113% Government 50 2,793 5,486% Union 5 412 8,140% Total 135 6,575 4,770% Source: The Money Market Directory, 2001, Standard & Poor s 3
US$ Billions 3500 Growth in Corporate Pension Fund Assets 3000 Total 2500 2000 Defined Contribution 1500 1000 500 Start of 401k Plans Defined Benefit 0 77 79 81 83 85 87 89 91 93 95 97 99 01 Source: The Money Market Directory, 2001, Standard & Poor s The blue line represents the total pension assets. The difference between the blue line and the red line is defined contribution. The red line is just defined benefit Note: These are only those funds listed in Money Market Directory, do not place emphasis on total number 4
Percentage of Defined Benefit Versus Defined Contribution Plans Percent of Total Corporate Pension Plans 100 80 60 40 20 0 77 82 Defined Benefit Defined Contribution 87 92 97 Source: The Money Market Directory, 2001, Standard & Poor s 5
Net Change of Corporate Defined Benefit Versus Defined Contribution 1986-2001, $US Billions 1986 2001 Change Defined 110 1,507 1,273% Contribution Defined Benefit 498 1,599 221% Total 608 3,105 411% Source: The Money Market Directory, 2001, Standard & Poor s 6
Historical Pension Fund Asset Allocation US$ Billions 1200 Equity Bonds 1000 800 600 400 200 0 50 55 60 65 70 75 80 85 Source: Trends in Pensions, Department of Labor, page 430, 1992 7
Change in Asset Allocation: 1990-2001 Average Percentage of Assets, Top 200 Defined Benefit Plans 70 60 Stocks Real Estate Fixed Income Alternatives Cash 50 40 30 20 10 0 1990 1992 1994 1996 1998 2000 2001 Source: Pensions & Investments 8
Private Equity 38% Allocations for Selected Alternative Assets: Top 200 Defined Benefit Plans 1997 2000 Distressed Debt 1% Private Debt 22% Venture Capital 36% Oil and Gas 3% Private Equity 68% Distressed Debt 3% Private Equity 66% 2001 Hedge Funds 3% Distressed Debt 1% Venture Capital 22% Oil and Gas 2% Private Debt 2% Venture Capital 28% Oil and Gas 1% Private Debt 4% Source: Pensions and Investments 9
Return and Risk by Asset Class 20 Years Ending 12/30/01 Avg. Return Avg. Risk 10 Years Ending 12/31/01 Avg. Return Avg. Risk Domestic Equity 15.5 14.6 13.7 16.2 International Equity 13.5 24.0 5.6 18.9 Long Treasuries 12.9 13.5 9.3 12.9 High Yield 12.3 11.8 9.2 8.9 High Grade 10.7 7.9 7.5 6.7 Alternative Investments 15.4 28.3 19.9 37.5 Sources: Domestic Equity: Russell 3000 International Equity: Ibbotson Long Treasuries: Combination of Ibbotson's Long Government Bond index and Lehman's Long US Treasuries index Alternative Investments: Combination of the Brinson VC index and the Venture Economics PVCI High Yield: Merrill High Yield Index High Grade: Merrill high Grade index 10
Return and Risk by Asset Class 5 Years Ending 12/31/01 Avg. Return Avg. Risk 2 Years Ending 12/31/01 Avg. Return Avg. Risk Domestic Equity 10.1 18.0-9.5 18.4 International Equity 6.3 24.6-1.2 35.6 Long Treasuries 8.4 7.5 12.0 7.7 High Yield 3.9 5.8-0.3 1.3 High Grade 7.5 5.5 10.2 2.5 Alternative Investments 8.4 7.5-31.6 76.5 Sources: Domestic Equity: Russell 3000 International Equity: Ibbotson Long Treasuries: Combination of Ibbotson's Long Government Bond index and Lehman's Long US Treasuries index Alternative Investments: Combination of the Brinson VC index and the Venture Economics PVCI High Yield: Merrill High Yield Index High Grade: Merrill high Grade index 11
Historical Return by Asset Class Average Annual Percentage Return 20 15 10 5 0 20 Years 10 Years Domestic Equity International Equity Long Treasuries High Yield High Grade Alternatives Sources: Domestic Equity: Russell 3000 International Equity: Ibbotson Long Treasuries: Combination of Ibbotson's Long Government Bond index and Lehman's Long US Treasuries index Alternative Investments: Combination of the Brinson VC index and the Venture Economics PVCI High Yield: Merrill High Yield Index High Grade: Merrill high Grade index 12
Historical Return by Asset Class Average Annual Percentage Return 20 11 2-7 -15-24 -33 5 Years 2 Years Domestic Equity International Equity Long Treasuries High Yield High Grade Alternatives Sources: Domestic Equity: Russell 3000 International Equity: Ibbotson Long Treasuries: Combination of Ibbotson's Long Government Bond index and Lehman's Long US Treasuries index Alternative Investments: Combination of the Brinson VC index and the Venture Economics PVCI High Yield: Merrill High Yield Index High Grade: Merrill high Grade index 13
Growth in International Equities Versus Bonds Source: Pensions and Investments 14
U.S. Average Life Expectancy 78 76 74 72 70 68 66 64 62 1940 1950 1960 1970 1980 1990 2000 Source: Center for Disease Control 15
Percentage Change in U.S. Population By Age Group, 2000 to 2025 100 80 60 67% 80% 40 20 14% 14% 0-20 0-17 18-34 -1% 35-54 55-64 65+ Source: Mike Milken s Slide 16
Actual Versus Expected Returns: Consolidated New York Pensions Annual Percentage 40 Actuarial Assumption Market Return 30 20 10 0-10 -20 80 82 84 86 88 90 92 94 96 98 00 Source: New York State Governor s Office of Employee Relations 17
Need for Different Pension Assets Endowment and Foundation Example Expected 5 Year Return Past 5 Year Return Domestic Equity 8.7% 10.1% Fixed Income 6.4% 7.4% Necessary Total Return to Pay Benefits 8.8% Source: Wall Street Journal, March 20, 2002 Expectations of fixed income returns and stock return data from Greenwich associates, Fixed income: Lehman US Aggregate Fixed Income 18
Source: Pensions and Investments 19
Growth in Institutional Ownership of U.S. Equity Percentage of Total Equity 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1945 1970 2001 Individuals All Institutional Investors State and Local Pension Funds Source: Flow of Funds report from the Federal Reserve. 20
Missing Proxy Activity Increases 21
Financing Retirement Then and Now 22
THEN 23
Then Domestic Equities 5 Years, as of 12/31/99 Average Return Average Risk 26.9 14.1 Alternative Investments Long Treasuries 42.5 9.1 33.3 8.1 Assets grew much faster than liabilities Result Pension Funds are in the best financial shape (assets/liabilities) ever!!! Sources: Domestic Equity: Russell 3000 Long Treasuries: Combination of Ibbotson's Long Government Bond index and Lehman's Long US Treasuries index Alternative Investments: Combination of the Brinson VC index and the Venture Economics PVCI 24
NOW 25
Now 5 Years, ending 12/31/01 Avg. Return Avg. Risk 2 Years, Ending 12/31/01 Avg. Return Avg. Risk Domestic Equities 10.1 18.0-9.5 18.4 Alternative Investments 18.7 54.6-31.6 76.5 Long Treasuries 8.4 7.5 12.0 7.7 Assets shrink and liabilities continue to grow Result Pension Funds are no longer in the best financial shape (assets/liabilities) ever!!! Sources: Domestic Equity: Russell 3000 Long Treasuries: Combination of Ibbotson's Long Government Bond index and Lehman's Long US Treasuries index Alternative Investments: Combination of the Brinson VC index and the Venture Economics PVCI 26
THE NEXT FIVE YEARS? 27
YTM on 20-Yr. U.S. Treasury Yield on 90-Day Bills P/E of S&P 500 5 Year SD of S&P 500 YTM High Yield YTM High Grade Inflation Last 12 Months RE Annual Income Return Then: 1999 6.6 5.3 32.0 14.1 11.5 7.6 2.7 8.3 Now: 2002 5.9 1.8 24.9 17.8 12.5 6.1 1.1 8.6 Source: Allen Emkin 28
GMO 7-Year Asset Class Return Forecasts As of March 31, 2002 14% Stocks Bonds Other 12% 11.7% 10.5% 10% 8% 6% 4% 2% 0% 1.0% 1.9% 4.1% 7.7% 2.2% 4.5% 4.9% 4.1% 3.8% 2.1% 2.2% 7.6% 5.5% 1.0% 1.0% 2.4% 2.7% 3.1% 2.8% 8.7% 2.2% 6.5% 0.3% 0.2% 3.6% 3.7% 1.6% 3.4% 2.1% 8.8% 8.5% 1.4% 9.1% -2% -0.9% -4% U.S. equities (large cap) U.S. equities (small cap) Int'l. equities (large cap) Int'l. equities (small cap) Equities U.S. Bonds Int'l. Bonds (emerging) (gov't.) 2 (gov't.) 3 Bonds (emerging) Bonds (inflation indexed) U.S. treasury (30 days to 2 yrs.) REITs Managed Timber Estimated Range of 7-Year Annualized Returns ±6.5 ±7.0 ±6.5 ±7.0 ±10.5 ±4.0 ±4.0 ±8.5 ±1.5 ±1.5 ±6.0 ±5.5 - Expected Value Added - Real Return (Asset Class Index) Source: Barron s Online, After the Deluge: An elegant thinker deconstructs the stock market's latest bubble and its likely aftermath, August 6, 2001. 29
GMO 7-Year Asset Class Return Forecasts As of March 31, 2002 10% U.S. Large U.S. Small Int l. Large Int l. Small 8% 7.6% 6% 5.5% 4% 2% 2.4% 4.5% 2.7% 1.3% 4.3% 2.3% 0.3% 0.2% 0% -2% -0.9% -1.8% -4% -6% S&P 500 US Large Growth US Large Value US Small US Small Growth US Small Value EAFE Intl Growth Intl Value Intl Small Intl Small Growth Intl Small Value Source: Barron s Online, After the Deluge: An elegant thinker deconstructs the stock market's latest bubble and its likely aftermath, August 6, 2001. 30
Absolute Return Portfolios Achieving High Real Returns with Reasonable Risk Expected Real Return w/ Alpha 12% 10% 8% 6% 4% 2% 0% 6.4% 6% 10% 8% 11% 9% 4% 50% 8.5% 19% 15% 10% 10% 20% 25% Global Equity Portfolio (Indexed) 3% 5% 7% 9% 11% 13% 15% Volatility 9.7% 25% 15% 15% 15% 10% 20% 1.0% REITs Int l Large Value Int l Small Value Emerging Equity Emerging Debt Market Neutral Aggressive Long/Short US Gov t Bonds Inflation Protected Gov t.. Bonds As of 3/31/02 Source: Barron s Online, After the Deluge: An elegant thinker deconstructs the stock market's latest bubble and its likely aftermath, August 6, 2001. 31
Low Return Environment for the 2000s Dividend Yield Historical Stock Returns 5.0 % Expected Stock Returns 1.5 % Inflation P/E Expansion Real Growth in Earnings/Dividends Total 2.5 % 2.0 % 1.5 % 11.0 % 2.5 %?? % 1.5 % 5.5 % +?? Source: American Airlines Presentation 32
Opportunities to Enhance Returns Return to fundamental value investing Small capitalization Emerging markets High yield bonds Private equity investments Source: American Airlines Presentation 33
Focus on Basics Active management vs. indexing Yields Disciplined rebalancing Low costs Source: American Airlines Presentation 34
Low Return Environment for the 2000s Warren Buffet Forecasts likely future returns of stocks at 7 percent per annum Long-term stock prices grow with corporate earnings which grow with GDP + dividends Unlikely to get lower interest rates which have driven an expansion of market P/E s since 1980 Corporate profits are normal relative to GDP Source: American Airlines Presentation 35