A “massive rotation” into corporate bonds from equities may be on the horizon for U.S. pension funds as they become fully funded, according to strategists at Bank of America Corp.

Investment gains boosted the funded ratio of the 100 largest corporate plans to 98.8% in May, according to Milliman. That measure of defined benefit pension assets to liabilities has surged from 82% since July 2020, data from the risk management firm show.

If interest rates continue to rise, BofA expects the ratio to top 100%. That would trigger a significant move into high-grade debt by corporate pensions seeking to lock in gains, the bank said in a credit strategy note entitled “The elephant in the room.”

“I think this becomes a pretty big story, and it becomes a support for credit spreads in the back end of the curve especially,” Hans Mikkelsen, BofA’s head of high-grade credit strategy, said in an interview.

Corporate pensions that are over-funded will likely sell riskier assets like equities and buy annuities from insurance companies, Mikkelsen said. Insurance companies would then hedge with mostly longer maturity, investment-grade corporate bonds.

“These are legacy plans. It’s been a headache for a long time for companies to have them and have them be underfunded,” Mikkelsen said. “Now they may be able to make that problem go away without putting any new money into it.”

Private defined-benefit pension plans held $3.5 trillion in assets at the end of 2020, with nearly half of that in equities, according to data from the Federal Reserve.

BofA expects wider high-grade U.S. spreads in the short term, foreseeing a faster rate-hiking cycle than is currently priced in by the market. If that happens, pension reallocation would likely support long-dated credit and flatten the spread curve, Mikkelsen added.

This article was provided by Bloomberg News.