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Home > Library > Stable Times > Volume 10, Issue 3
The quarterly publication of the Stable Value Investment Association
Third
Quarter 2006 • Volume 10 Issue 3
Editor's Corner
By Stephen Lelauren, INVESCO Institutional
Sometimes when you are in the midst of busy times, you cannot tell how intense life really is. Stepping away from it often gives perspective on just how busy things really were.
Maybe I am over-reading things, but it does seem to me that 2006 may be a pivotal year (or at least noteworthy) in the stable value world. When we look back on this year, we might collectively say “WOW! Look at all the things that happened in 2006 that now shape stable value investments.”
Consider these observations about 2006, many of which are highlighted in this Stable Times issue:
Flat-yield curves have produced money market fund yields near or above stable value yields … certainly a point of nervousness in the stable value industry. But other than industry handwringing, we haven’t seen much backlash from plan sponsors or participants. Once again, volatility in the stock market and the economy is stable value’s friend.
Steadily rising interest rates have also been our friend, at least compared to bonds. While that trend puts pressure on the “stable value vs. money market” comparison, it does produce very low or negative bond fund returns. This again highlights the advantage of low volatility in stable value.
FASB has delivered accounting guidance that reinforces stable value accounting for single-employer plans and pooled funds. It will take effect this year.
GASB may clarify book-value accounting treatment of stable value funds in state and local government and 529 savings plans. They are now in the process of review.
Pension reform will enhance the stature of defined contribution plans overall. Defined contribution plan growth could certainly mean stable value asset growth.
A number of 529 college savings plans are now using stable value investment options, and it may be a trend that continues.
Pension reform also made permanent favorable tax treatment of 529 plan distributions, thus eliminating some uncertainty from 529 plan growth. Coupled with growing use of 529 plan stable value options, there is a chance for significant stable value growth in this area.
There is a slow and steady “movement” among plans to use collective trust arrangements instead of mutual funds. The drive here is to save the costs unavoidably embedded in mutual funds. The DOL’s pressure on plans to disclose expense ratios more clearly may be a big influence in this investment delivery shift. (More on what this means to stable value below.)
Most lifecycle (or life-stage, lifestyle, or target-maturity) investment options have been invested in mutual funds, using money market funds as the conservative investment. But we have worked hard to convince the defined contribution community of the superiority of stable value over money market funds. Some plan sponsors have already gotten or will get their record keepers to create a custom lifestyle option for their own plan options, including stable value.
The increasing interest in collective trust arrangements may induce collective trust companies to expand or create their own lifecycle “funds,” using their own stable value collective trust fund as the conservative investment piece. When/if this happens, there will be a good alternative to the lifecycle mutual funds that use only money market funds as the conservative investment.
Lifecycle options tend to evolve towards conservative investments, so those with stable value as the conservative investment will grow their stable value assets as their participant population ages.
The growing use of lifecycle options with stable value could serve to stabilize cash flow volatility in stable value options. There just won’t be as much incentive or interest among participants to make many investment changes. While stock market gains and declines could result in rebalancing ins-and-outs from a stable value fund among many clients, there should also be a steady influx of stable value dollars as the population ages.
Automatic enrollment is likely to have a huge effect on the entire DC plan landscape, and in particular stable value. Certainly auto-enrollment all by itself could have some positive effect, although most auto-enrolled participants will be younger employees who perhaps are less interested in stable value.
The biggest potential 2006 effect on stable value is changing default options. Imagine two alternative scenarios:
- Lifecycle options become the standard default, auto-enrollment gets into every plan, many employers force their employees to re-enroll, and mutual funds are the only game in town for lifestyle funds. RESULT: a potentially significant reduction in stable value balances, at least initially.
- Same as above, except that plans adopt their own lifecycle programs from within their own plan options, or they add collective trust lifestyle vehicles with stable value as a component. RESULT: only modest decreases, or maybe even some increases, in stable value balances.
In both cases, I expect that once the early dust settles, stable value allocations in plans (regular stand-alone stable value, plus stable value imbedded in other plan options) will tend to stabilize. Reason: As noted above, participants will have very little incentive to reallocate since the lifecycle options take care of that for them.
The rest of the year should prove interesting, perhaps as a prelude to the future.
Read Next: GASB Derivatives Project Looks at Synthetic GICs
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