Pension funds can make a big splash when they all jump into financial markets at the same time.
That's pretty much been the experience in the bond markets this year, a phenomena that has helped keep rates low and provided a steady stream of buyers for Treasurys and corporate bonds, according to strategists.
But now that it's getting into September, many pension funds, after diving in big time, may be ready to get out of the pool temporarily — or at least slow fixed income investments as summer moves into fall. That's because when the tax law changed last year, many companies were given until mid-September to deduct their pension contributions at last year's tax rate instead of the new 21 percent rate.
The buying was especially strong in the spring and summer and has clearly been a factor weighing on yields. Bond prices move opposite yields, so pension fund buying in theory would have helped keep yields lower in the Treasury market and corporate bond market than where they have been. The 10-year yield, for instance, reached its high of the year at 3.12 percent on May 18 and was at 2.84 percent Tuesday.
"They're not going going to jump out, but they are going to climb out," said Michael Schumacher, director rates strategy at Wells Fargo. Private pensions hold about $3 trillion in assets. Schumacher said the pre-tax deadline buying was so strong, it likely had a short-term impact of holding long-term rates lower. Those yields could now move higher later in September, as fund buying slows.
In the same time frame, Turkey's currency crisis has been weighing on yields but other factors that would have sent them higher have not had much impact.
"It's a powerful argument," said Schumacher. "If you think about the changes since May, we had definite increases in Treasury supply, and it's been more skewed toward the long end, and yet yields are down...Overseas buyers have been absent, and still yields are down."
But strategists say even after this surge in tax-related buying ends, there is another big driver for pension funds that will keep them buyers in the market, though not at the same hefty pace. There is critical longer-term desire to reduce risk — and that means funds will remain big buyers of bonds, a trend that could keep rates from rising more dramatically.
"There is a tax advantage for most plans to make a contribution prior to Sept. 15 of this year...saving 14 cents on the dollar," said Matt McDaniel, a partner with consulting firm Mercer, who leads the U.S. financial strategy group. "Unsurprisingly, a lot of corporations are looking at that and saying: 'Gee our pension plan is underfunded. Why wouldn't we accelerate that cash and fund it on a cheaper basis.' This in turn generates dollars into the pension system that has to go to work."
The trend to reduce risk should keep pensions big buyers of fixed income in the future and make them less dependent on equities, as many corporate-sponsored plans pay out benefits to retirees but no longer gain contributions from workers.
McDaniel said pension funds have been looking to reduce risk, as assets have risen with the stock market's gains, after diving during the financial crisis. "They're making these decisions at the same time they have a desire to reduce risk. 'Buying long Treasurys and long corporate bonds that move in tandem with my pension liabilities are going to reduce my overall financial risk,'" he said.