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JPMorgan Asset Management Recommends Corporate Finance Approach to Pension Management in the U.S.

Jan 17, 2007

White Paper details Pension Risk Framework Solution for U.S. Corporate Pension Plans and their Sponsors

New York, January 17, 2007 - JPMorgan Asset Management (“JPMAM”) today unveils its newest thinking in effective pension plan management, a white paper entitled, “Corporate Finance Meets Pension Management: a New Era for Pension Leaders”.  In the light of new funding regulations and accounting rules, JPMAM’s white paper is proposing a ‘corporate finance approach’ to U.S. corporate pension plan management, and details a new holistic pension risk ‘framework’ for corporations to adopt.  The proposed approach is designed to bring long-term stability and improved financial health both to the pension plan and the organization that sponsors it.

A Corporate  Finance Approach:
With the passage of the Pension Protection Act of 2006 (PPA) and the issuance of SFAS 158,  JPMAM is recommending that pension plans dramatically rethink their existing approach to asset allocation and risk management by adopting a ‘corporate finance approach’ to pension plan management. Applying to pension plans the same risk management tools guiding a company’s core business units will enable senior management to make more informed pension decisions - and assess the potential impact of those decisions on both the plan and shareholder value. 

The corporate finance approach intends to identify an asset allocation that achieves the desired level of return for the pension plan while empowering the CFO and CIO to:
• Gain greater control over the balance sheet risk exposures resulting from the plan,
• Reduce the level and volatility of contributions,
• Minimize corporate earnings at risk.

A Pension Risk Framework:
JPMAM believes that traditional asset-only assessments of pension plan performance are misguided, and now out of date. JPMAM, in its white paper, suggests a new rigorous framework, which provides tools for measuring, monitoring and managing pension plan risk from both a traditional plan based perspective and also from a corporate finance perspective - and a new model for determining the relative attractiveness of one asset allocation to another.  With this, CIOs will be able to assess the impact of the new funding regulations and accounting rules of their plans and on the company. They will also be able to structure efficient portfolios that both ensure the benefit security of plan participants, and more effectively manage the risk the pension plan brings to bear on the corporate sponsor.

The first part of the framework, comprising three new pension metrics*, is designed to measure the risk in the assets and liabilities of a company’s pension plan on overall corporate risk. Using this method, CFOs, Treasurers and CIOs can determine how much risk the pension plan should represent (to a corporation) in different macroeconomic scenarios and or points in a corporation’s business cycle, and match the risk profile of the plan to the company’s available risk capacity. By defining risk in these terms, JPMAM believes that this framework will both strengthen the pension plan – and enhance shareholder value.

The second part of the framework looks at portfolio construction and addresses the plan’s key market risk exposures – the volatility of equity markets and of interest rates. Key recommendations from JPMAM are the reduction of “uncompensated” interest rate risk by narrowing the duration mismatch between plan assets and liabilities and the management of the risk of equity concentration in a pension plan through the implementation of a ‘Broadly Diversified Investment Portfolio’.

This proposed asset allocation model is designed to generate the return needed in the plan, within risk levels established by senior management. This means that each pension plan will have a very customized asset allocation verse the standard 60% equity, 30% fixed income and 10% alternative assets allocations produced with traditional asset/liability optimization models.

Broadening the Investing Universe:
To reduce the traditional reliance on public equities, which represent a magnified risk with balance sheet exposure, JPMAM is further recommending that corporations broaden their plans’ investible universe.

JPMAM predicts that within the next five years (particularly after FASB Phase II), the typical final pay pension plan will have from 25% to 35% of its assets invested in non traditional asset classes, versus about 8% today. Cash balance plans are likely to have even higher alternative allocations, representing up to 50% of plan assets.  Hedging a plan’s interest rate exposure, reducing it’s long-only equity stake, and investing in a wide range of beta and alpha sources is the winning approach according to JPMAM.   JPMAM foresees the push for diversification, not only at the asset class level - but also geographically. The ideal investments will be those that generate attractive returns while having relatively low correlations of returns.

Bill McHugh, Group Head, Strategic Investment Advisory Group, JPMorgan Asset Management, said: “The corporate finance approach is the way forward for typical U.S. corporations now that changes to accounting rules and funding regulations have made the risk exposures associated with managing pension plans more transparent.  We believe that the viability of the typical corporate pension plan in America depends on the adoption of this type of approach to pension management.  In this new environment, the leadership of the CIO has never been needed more than now."

He added: “The framework we propose in our paper is not a one-size-fits-all solution – it will benefit companies differently – depending on plan assets, liabilities and surplus relative to profits and shareholder equity, firms’ cost of capital and access to funds and firms’ views on interest rates and hedging risks. It will produce customized asset allocations based upon the unique characteristics of the plan and its corporate sponsor.  This structure enables plan sponsors to manage their plans in a manner that both enhances participants’ benefit security and shareholder value.  

JPMAM is hosting a conference on this topic in New York City for CIOs, CFOs and Treasurers “Corporate Finance Meets Pension Management” February 5-6 2007.

For further information about the conference, or a copy of the white paper please email:  jpmam.info@jpmorgan.com

Notes to Editors:

The White Paper:
*The first component of the framework is made up of three metrics based on corporate finance concepts, that estimate the effect of defined benefit plans on corporate shareholder equity, cash flow and earnings. These metrics quantify the charges or credits to shareholder equity, cash flow and earnings from changing conditions in the financial markets and changes in portfolio asset allocation.

The Strategic Investment Advisory Group:
The Strategic Investment Advisory Group partners with clients to develop objective, thoughtful solutions to the broad investment policy issues faced by corporate and public defined benefit pension plans, insurance companies, endowments and foundations. The global team is one of JPMAM’s primary centers for thought leadership and advisory services for institutional clients in the areas of asset allocation, pension finance and risk management.

About JPMorgan Asset Management:
With $935 billion as of September 30, 2006*, in global discretionary assets under management, JPMorgan Asset Management is one of the largest active asset managers in the world and one of the largest mutual fund companies in the United States, providing institutional, ultra high net worth and retail clients with outstanding investment products across all asset classes globally, including fixed income, equity, liquidity, real estate, private equity and hedge funds. 

*Based on AUM for the Asset & Wealth Management (JPMAM, PB, PCS) division of JPMorgan Chase & Co. as of September 30th, 2006.

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Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The view and strategies described may not be suitable for all investors. 

JPMorgan Asset Management is the marketing name for the asset management businesses of JPMorgan Chase & Co. Those businesses include J.P. Morgan Investment Management Inc., JPMorgan Investment Advisors Inc, JPMorgan High Yield Partners, LLC, Security Capital Research & Management Incorporated and J.P. Morgan Alternative Asset Management, Inc.