- Investment Strategy Analyst
United States, Institutional
Change
The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
Key points
- Corporate plan ROAs are declining gradually, but higher capital market return assumptions, a result of lower asset valuations and higher yields, may cause this trend to reverse.
- Revision activity in public plan ROA assumptions has picked up somewhat in recent years but is still slower than for corporate counterparts. The latest reported average ROA assumption is 6.9%.
- In terms of capital market assumptions, we continue to predict that long-term equity and bond returns will not keep pace with the returns of the last 50+ years.
- We recommend that sponsors develop their investment policy based on their specific risk and return objectives and time horizon, rather than tying investment policy to a specific long-term ROA to manage pension expense or the reported liability.
As part of their year-end reporting process, US corporate and public defined benefit (DB) plan sponsors must set an assumption for the long-term expected return on assets, or ROA. To help sponsors make more informed decisions, we provide this annual update on ROA assumptions, including our latest trend analysis and long-term capital market assumptions.
Corporate plans
Corporate sponsors use the ROA assumption to determine the pension expense recognized on their income statements. Under US accounting standards, the pension expense includes a credit (income) equal to the plan’s expected return on assets during the fiscal year.
The average ROA assumption reported by Russell 3000 companies at year-end 2021 was 5.2%, roughly 40 basis points (bps) lower than in 2020 (Figure 1). This continues a downward trend — although, as we note later in this paper, we think the trend may reverse in 2022 or 2023 given higher capital market return assumptions. The average ROA assumption has fallen 270 bps since 2006, when the introduction of mark-to-market balance sheet accounting for pension plans by the Financial Accounting Standards Board (FASB) and the passage of the Pension Protection Act by Congress first prompted many plan sponsors to reevaluate their investment strategies.
Figure 1
The distribution of ROA assumptions (Figure 2) sheds additional light on the decline in the average assumption. In 2006, just over 10% of companies selected an ROA assumption below 7.0%. But by 2021, nearly 90% of companies selected an ROA assumption below 7.0%, and the distribution of assumptions skewed more heavily downward than in the past.
Figure 2
Two dynamics have driven the long-term decline in the ROA assumption: higher fixed income allocations, which have increased more than 20% since 2006, and lower forward-looking return expectations, especially in fixed income given the long-term decline in interest rates. Fixed income allocations at year-end 2021 were about…
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- Investment Strategy Analyst
- Multi-Asset Strategist
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