Shared Characteristics of Outperforming Plans Can Serve as Best Practices for Underperforming Plans

BOSTON, December 1, 2004 - While the current market environment continues to present funding challenges for many defined benefit pension plan sponsors, a study released today by Fidelity Investments reveals that nearly 2,635 of the 7,320¹ U.S. pension plans, or 36 percent, are overfunded², and that the majority of these plans have outperformed³ underfunded plans, achieving an average annual return of 5.45 percent versus 4.60 percent over the last five years⁴. This 85 basis point performance gap can equate to $52 million fewer assets for a $1 billion plan⁵ over a five-year period.

According to the Fidelity study, "No Time for Complacency," overfunded pension plans share three management characteristics that contribute to their outperformance. They are opportunistic in their asset allocation intentions, active in their risk management, and nimble and flexible in their investment manager hiring practices.

"Despite a rebound in the equity markets in 2003, the 'perfect storm' of 2000, 2001 and 2002 - negative equity returns combined with historically low interest rates - continues to present significant funding challenges for pension plans, especially for the nearly two-thirds of plans that remain underfunded," said Drew Lawton, president, Fidelity Management Trust Company.

"While all plan sponsors should implement a management approach that is appropriate for the specific needs of their pension plan, the findings of our study present an interesting opportunity for underfunded plans to benchmark themselves against peers and identify best practices that, when implemented, could have a positive impact on the long-term performance of their plan," Lawton said.

Opportunistic in Their Asset Allocation

While asset allocations vary only slightly between outperforming and underperforming plans, overfunded plans anticipate that they will be more active in their asset allocation over the next 12 months. They also foresee increasing their holdings mainly in non-traditional investments, including non-U.S. equity, real estate, and hedge funds.

According to the Fidelity study, one in three (32 percent) defined benefit plan sponsors believe that the biggest trend in pension asset allocation over the next 10 years is that future allocations will be more global rather than U.S.-centric.

"Over the last couple of years, we have found that plan managers are demonstrating a heightened interest in non-U.S. equities, whether increasing their overall global allocation or adding another level of diversification within their existing portfolio," Lawton said. "In fact, since 2000, our international equity assets have increased 356 percent and our number of clients invested in international equity has increased 210 percent."

Active in Their Risk Management

Although outperforming plans focus on asset classes with higher reward/risk profiles, the study finds that a plan's appetite for risk is inversely related to funding status. To that end, outperforming plans report that they are less aggressive in their risk tolerance today than they were five years ago, with 22 percent (versus 9 percent of underperforming plans) saying that they are more conservative.

In general, plan sponsors are taking risk management more seriously. However, outperforming plans are the ones opting for even more sophisticated measures of risk. Overall, 30 percent of plan sponsors view volatility of the pension surplus/deficit as the best measure of risk, indicating that plans are now linking their assets and their liabilities. Outperforming plans tend to go one step further, being more likely than underperforming plans (10 percent to 2 percent) to look at the downside risk, not simply at how risk is measured against the S&P 500 Index^®.

Nimble and Flexible in Their Hiring Practices

All plans indicate that they spend more time on investment manager selection than asset allocation; however significantly more outperforming than underperforming plans spend the majority of their time on manager selection (81 percent versus 56 percent).

Outperforming plans also are more flexible in their manager selection and oversight. They have lower manager turnover, with 57 percent (versus 47 percent of underperforming plans), experiencing an annual turnover rate of 4 percent or less. They also exhibit more patience when replacing a manager, with 10 percent waiting four to five years to terminate. Outperforming plans are more likely to hire a manager without a track record, while underperforming plans are inclined to never consider managers who have under-performed in the near term (one to three years). Outperforming plans also give greater freedom to their investment managers, including less restrictive risk guidelines and more absolute return objectives.

"It may seem surprising that pension plans, including outperforming ones, focus more on manager selection when they see asset allocation as more important to a plan's success," said Lawton. "However, we believe that plans, especially outperformers, realize the importance of maintaining a consistent asset allocation and, therefore, turn their time to a factor that they can evaluate and fine-tune on a more regular basis.

"This sharp focus on manager selection, coupled with their nimbleness, may help to explain a plan's positive performance and funding status when there is no perceivable difference in asset allocation among all plans," added Lawton.

The Future Remains a Challenge

According to the Fidelity study, plan sponsors anticipate that the future will continue to bring significant challenges. The three biggest threats identified include: a market downturn, the relative cost of defined-benefit versus defined-contribution plans, and demographic shifts.

"Over the last three years, our annual research has served as a means for plan sponsors to gauge and reflect on current market trends as well as anticipate and plan for the future," Lawton said. "We are committed to continuing to provide the pension industry with insight to help plan sponsors, in collaboration with their consultants and investment managers, evaluate their investment and management approach to ensure that they are meeting their long-term goals."

About the Study

"No Time for Complacency" is the third annual nationwide study of defined benefit plan sponsors conducted by Fidelity Investments with PLANSPONSOR, a leading magazine for retirement executives. PLANSPONOR collected data between June 28, 2004 and August 16, 2004 through a questionnaire sent to defined benefit plans of all sizes. A representative sample of 120 plans responded, including 100 with more than $200 million in plan assets (7.22 percent of market), 88 with more than $500 million in plan assets (11.81 percent), 51 with more than $1 billion in plan assets (20.00 percent) and 18 with more than $10 billion in plan assets (24.00 percent). Public/government plans accounted for a majority of responses (55 percent), while corporate plans constituted the next largest representation (45 percent). Fidelity Management Trust Company was responsible for the analysis of the data.

About Fidelity Management Trust Company

Fidelity Management Trust Company manages $93 billion for 521 institutional clients worldwide as of October 31, 2004, including corporate and public retirement funds, endowments, foundations and other institutional investors. The company offers institutional asset management for active and risk-controlled equity, fixed-income, international equity, real estate and alternative disciplines such as market neutral. The company is affiliated with Fidelity Employer Services Company, which provides benefits and human resources administration, workforce effectiveness, payroll solutions and stock plan services to over 18 million employees in the U.S. as of October 31, 2004.

About Fidelity Investments

Fidelity Investments is one of the world's largest providers of financial services, with custodied assets of $1.9 trillion, including managed assets of $1.0 trillion as of October 31, 2004. Fidelity offers investment management, retirement planning, brokerage, human resources and benefits outsourcing services to more than 19 million individuals and institutions as well as through 5,500 financial intermediaries. The firm is the largest mutual fund company in the United States, the No. 1 provider of workplace retirement savings plans, one of the largest mutual fund supermarkets and a leading online brokerage firm. For more information about Fidelity Investments, visit www.Fidelity.com.

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Fidelity Distributors Corporation 82 Devonshire Street, Boston, MA 02109

¹ Nelson's Database as of 6/30/04.

² Includes fully funded.

³ Outperforming plans are those that are above the median for five-year returns ended 12/31/03.

⁴ For fiscal year ended 2003.

⁵ On a $1 billion pension plan, 4.60 percent over five years returns $1.252 billion. 5.45 percent over five years returns $1.304 billion. The difference of 85 basis points amounts to $52 million over the five-year horizon.