But investment consultants say that the statistics on asset allocation obscure the extent to which corporate defined-benefit plans are, in fact, rethinking the way they invest. The new line of reasoning: The proper way for corporations to offset pension liabilities, which are bond-like in nature, is with bonds and not stocks. British retail pharmacy giant The Boots Group PLC cited this logic a little more than a year ago when it moved all of the $3.3 billion in its defined-benefit pension plan into fixed-income securities. Of course, Boots had the additional incentive of Financial Reporting Standard 17, a new U.K. accounting regulation that will force companies to mark pension assets to market. Because of the volatility in equity values, the rule tends to put a premium on the stability of bonds

Although the retailer denied that the pending rule figured into its calculations, British accounting experts have been predicting a shift in pension assets to fixed income since it was first proposed in 2000. The rule was to have been adopted this year, but heavy criticism from companies forced British regulators last November to postpone implementation until 2005, although they're encouraging companies to do so sooner.

By that time, a version of FRS 17 is likely to have spread to the continent. The International Accounting Standards Board is currently updating its own pensions standard, IAS 19, under the leadership of Sir David Tweedie, who headed up the U.K.'s Accounting Standards Board when it developed FRS 17. Given that Tweedie has already indicated that it is his desire that the IASB follow the British lead on this rule, the odds are quite high that the international board will eventually adopt this approach.

Underfunding in the Limelight

The U.S. currently allows companies to spread changes in the value of plan assets over a number of years. However, changes in those rules may be just a question of time since the FASB, SEC and IASB have recently begun efforts to create a consistent set of global accounting standards.

If the merging of U.S. and international accounting regulations seems too far off to worry about, then consider that companies are being called on the carpet daily because of the pension shortfalls created by the continued deterioration of the equity markets. "There are many, many more analysts and investment banks that are now focused on this and writing articles about the underfunding," says Mike Johnston, actuarial practice leader at Hewitt Associates of Lincolnshire, Ill. "Even if the accounting standards take a while to catch up, companies are getting beat up by the stock analyst community."

As Ethan Kra, chief actuary at Mercer Human Resource Consulting, puts it: "If you asked me to look in my crystal ball, 10 years from now, pension plans in this country will have vastly higher fixed-income exposure and much lower equity exposure."

But as much as many plan sponsors might like to chuck equities for the relative comfort of fixed income, few want to do it now. While there's a lot of talk about changing their asset allocations, "the problem right now is that, for people to make that change, they're effectively selling stocks low and buying bonds high," Johnston notes. "So I haven't heard of lots of people actually pulling the trigger on this."

Concerns about the wisdom of investing pension plan assets in the stock market are nothing new. "Thirty years ago, if you looked at what defined-benefit pension plans invested in, they would have been much heavier in bonds," says Olivia Mitchell, a professor at the Wharton School at the University of Pennsylvania and executive director of the Pension Research Council. In fact, she notes, many public plans were even prohibited from investing in stocks or limited as to how they could invest.

Meanwhile, the debate rages on, with the stock market's dive lending new weight to the virtues of fixed income. Some academic research, including papers by such notables as Fisher Black, one of the creators of the Black-Scholes option pricing model, argues that since pension liabilities are similar to bonds in nature, offsetting those obligations with stock holdings leaves plan participants open to the risk of a mismatch in the behavior of stocks and bonds. Charles Cowling, an actuary and worldwide partner in the retirement practice of Mercer Human Resource Consulting in London, who advised Boots on its shift, points out a company wouldn't issue bonds to raise money and then invest that money in the stock market. "So why does it do it in the pension scheme?"

Equity investment proponents, such as George Oberhofer, a senior practice consultant at investment services provider Frank Russell Co., claim that these arguments miss the most obvious reality: Over the long haul, stocks have provided a much higher return. Oberhofer also points out that to the extent that a company would be forced today to actually borrow money to buy bonds to offset its pension liabilities, the decision would then increase the company's leverage, its risk and the risk to plan participants, since the company is the guarantor of their pension benefits.

Some U.K. pension plans have followed Boots' example and shifted assets from stocks to bonds, although none has made as radical a move as Boots, Cowling says. Indeed, with London's FTSE off almost 50% from its all-time high in late 1999, U.K. plans are just as reluctant as their U.S. counterparts to lock in losses. "The only way of getting out of this hole is to put more money in. It's why there hasn't been a wholesale switch," Cowling says. Even so, he predicts more plans will shift more assets into fixed income once the stock market recovers.

Cowling says that although Boots was not trying to time the markets, it managed to get out before the bulk of the price deterioration. And Boots didn't expect its fixed-income assets to take care of all its pension liabilities. It estimated that it will need to make a contribution of about $81 million a year to the plan, offset somewhat by the almost $16 million in savings it expects to realize by moving to a passively managed bond portfolio from an actively managed stock portfolio.

So far, Boots looks pretty smart, thanks to the continuing deterioration of stock prices and appreciation in bond prices. "Boots is a company now where pensions are something we don't have to worry about," says David Stoddart, a retail analyst at Teather & Greenwood Ltd., a London-based stock broker.

While there is strong logic supporting a shift based on the current dismal state of equities, there is still no consensus about which–equities or fixed income–is in fact the correct course. The problem: Where are equities headed over the mid- to long-term? Those arguing for a diminished risk premium for stocks generally cite either the average dividend yield, which is at a record low level, or the price/earnings ratio, which has hit off-the-chart highs by historical standards, as the basis for expecting equity returns to be substandard going forward. A notable few are even more pessimistic: Robert Arnott of First Quadrant, an investment advisory firm in Pasadena, Calif., has argued for a "zero" equity risk premium.

Dimming Bond Prospects

This sentiment is clearly at the fringes, with the consensus putting the premium somewhere between 2% and 3%, compared with the historical premium of about 4%. Grant Gardner, director of capital markets research at Frank Russell, says talk of a zero or negative equity risk premium is "implausible" because stocks are fundamentally riskier than bonds and "risk has to be rewarded. If you didn't think you would get a higher return for holding a riskier asset, you wouldn't hold it," he says.

William Reichenstein, who holds the Powers Chair in Investment Management at Baylor University, notes that some of the calls for a declining equity risk premium were written two or three years ago, when U.S. stocks were at much higher levels. "Now that we've come much further down, by any of those models, prospects look much better," he says. That said, Reichenstein still expects stocks to perform below their long-term historical average of roughly 7%.

So is it time to move out of stocks? The main investment alternative carries risks as well. With interest rates at 40-year lows, the most likely scenario is for rates to rise in coming years, pushing bond prices lower. Reichenstein says that in his own portfolio, he has over-weighted stocks for the first time in five years, "not because I think stock prospects look above average, but because I think bond prospects look well below average."

Reichenstein says that if he were running a pension plan, he would concentrate on limiting expenses and plan on making a big contribution every year. "Your future returns are not going to be particularly strong," he says. "It's not much more complex than that."