Stable value funds have always played the role of the safe option within plan participants' 401(k) retirement portfolios. The funds were first introduced following the passage of the Employee Retirement and Income Security Act (ERISA) in 1974. The evolution and growth of the stable value market coincided with the growth of the 401(k) and defined contribution (DC) industries. The asset class has evolved since that time, but continues to remain a staple in many plan participants' retirement portfolios.
"They were designed to provide a safe investment option for a well-designed DC plan, by combining the best of both worlds, offering principal-protection and adequate returns with very low volatility," said James King, Senior Vice President and Head of the Stable Value Markets Group for Prudential Retirement. Stable value funds also provide an attractive alternative to other safe investment options, such as money market funds and intermediate term bond funds. Plus, they give participants the benefit of responsive payments at virtually all times, King noted. Stable value fund managers generally invest in high quality fixed income securities with intermediate-term maturities of up to three to five years. The funds typically hold a combination of corporate and government bonds and securitized products, and are protected by wrap contracts, which guarantee the investors' ability to transact at book value in the case of redemption.
The stable value industry is finally starting to reach an optimal balance between supply, demand and pricing for stable value wrap products.
Insurance companies were the dominant players in stable value wrap products back in the late 1970s and into the 1980s when the product was first introduced. In the early 1990s, the banking industry began to provide many of the wrap products used by the stable value industry. Since the financial crisis, however, many banks have moved to shrink their balance sheet and their off balance- sheet potential liabilities, including wrap contracts, especially since these products were never a big business for the banks to begin with.
The move caused a lack of supply. "There has been a supply/demand imbalance in the wrap industry and the situation was only exacerbated post the crisis," said Peter Chappelear, Managing Director, Head of Stable Value at JP Morgan Asset Management. "The dynamic had been that the wrap market had become a bank-dominated marketplace, whereas it used to be a mix of bank and insurance companies doing business. But over the years the banks had basically commoditized the product and made very homogenous terms, pushing the price down to very low levels," said Chappelear.
Stable Value funds are also sometimes compared to intermediate bond funds. "Money market funds and stable value funds are fundamentally different investment vehicles, so you really can't make an apples to apples comparison," said Karl Tourville, a Managing Partner at Galliard Capital Management, an investment management firm specializing in fixed income and stable value management for institutional investors. "Even though they're both conservative investment options, with similar investment objectives, how you arrive at that objective is quite different," he noted.
Especially in today's low interest rate environment, the spread differential between money market funds and stable value funds makes investing in a stable value fund a great option for defined contribution plan participants, said Warren C. Howe, National Sales Director for Stable Value for MetLife's Retirement & Benefits Funding team. "You can say that the value of stable value has never been more apparent than it is at this time," he noted.
Throughout the financial crisis, stable value funds consistently outperformed money market funds. In February 2012, money market funds earned about .03%, according to iMoneyNet data, a provider of money market fund news information and analysis. By contrast, stable value funds, which offer comparable safety to money market funds, boasted returns of 2.99%. "Stable value is now being viewed as a safe haven offering principal protection as well as upside," said James King, Senior Vice President and Head of the Stable Value Markets Group for Prudential Retirement.
Since the days of the financial crisis in 2008, investment guidelines for managing the underlying assets in stable value portfolios have become more detailed. "Investment guidelines were more ambiguous in the past, but have now added a greater level of specificity," said Warren C. Howe, National Sales Director for Stable Value for MetLife's Retirement & Benefits Funding team.
In general, the type of investment that stable value fund managers use has remained unchanged: safe, highly rated, fixed income securities. But in the past, a lack of specificity around some investment guidelines left some room for interpretation.
Today, wrap providers are working with investment managers and plan sponsors to update and adjust investment guidelines accordingly. While this process is ongoing, guidelines now specifically address both the asset sectors that a portfolio can use as well as the exposure to any individual security and asset class, Howe said.
In terms of the underlying assets in stable value portfolios today, the duration of bond maturities the funds can now invest in are generally lower and the credit quality restrictions are slightly higher, noted Karl Tourville, Managing Partner at Galliard Capital Management, an investment management firm specializing in fixed income and stable value management for institutional investors. There have also been more sector allocation limits, to promote diversification in portfolio management, he said.
In recent years, government agencies including the Department of Labor (DOL), the Senate Special Committee on Aging and the Government Accountability Office have been calling on money managers and financial services providers to become more transparent about the fees imposed on the products they offer and how the products work. "There's been a growing effort on the part of managers to be more transparent and to add more clarity to what stable value funds are," said Karl Tourville, Managing Partner at Galliard Capital Management, an investment management firm specializing in fixed income and stable value management for institutional investors.
With the heightened transparency in the defined contribution (DC) space, plan sponsors are doing a much better job of describing stable value funds to plan participants, noted Peter Chappelear, Managing Director, Head of Stable Value at JP Morgan Asset Management. Even so, many plan participants remain uninformed. "Most participants out there, despite more information on stable value, still don't understand what it is, and many don't care to understand," said Chappelear. "What they do care about today, is that the product is in a money market package, and it's got a yield that's well north of zero," he said.
Stable value funds are the principle asset preservation option in many defined contribution plans. Compared to other principle preservation options or fixed income fund options that may be available, including money market funds, stable value funds offer the best option, said Warren Howe, National¬ Sales Director for Stable Value for MetLife's Retirement & Benefits Funding team. ‘While stable value crediting rates have come down over time, as the interest rate environment has declined, compared to money market funds there is still a tremendous value proposition there," he said.
The balances on stable value funds are typically protected, as with money market funds, but one feature that makes stable value funds particularly attractive is that stable value funds are generally dollar per share, and the yield on the fund is considerably higher than that of a money market fund, said Peter Chappelear, Managing Director, Head of Stable Value at JP Morgan Asset Management. "Historically, it's been about 2% higher than money market funds and that's a big premium," he said.
As interest rates have come down to extremely low levels in the current economic environment, so have stable value fund yields. "But the way stable value yields move is kind of on a lagged and muted basis. So when rates trend down, stable value fund yields will trend down, after a delay. It won't exactly match the level of rate moves, but it will follow those yields," Chappelear noted.
The high amount of volatility in the financial markets these days has many defined contribution (DC) plan sponsors on edge. Rather than tie up plan participants' assets long-term, they are looking into alternatives to stable value products. Not all the solutions they are finding, however, are good or viable choices. "The natural alternatives are things like money market funds or a money market fund and a short bond fund, but they're not good alternatives, and the plan sponsors quickly realize that," said Peter Chappelear, Managing Director, Head of Stable Value at JP Morgan Asset Management. "A money market fund in a DC lineup that captures anything more than 1% to 2% of a participant's assets is just not a good solution; it's not going to prepare anybody for retirement, and plan sponsors are aware of that," he said.
The predicament has lead many in the DC marketplace to look for other alternatives to stable value. One product that is gaining a lot of traction and positive response from the plan sponsor community is the notion of offering a low-volatility, safe product, similar to a stable value fund. It is a stable income floating net asset value fund. The price of the NAV fund can go up and down each day, but is designed in a prudent way, such that over a period of one or even three months, the price doesn't go down, Chappelear explained. "It still protects participant balances, and that's what participants value the most from stable value; they don't want to lose money and that's why they allocate funds to these floating NAV product," he said. "It also relieves plan sponsors from many of the frustrations that come from the wrap market," Chappelear noted.
