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Home > Library > Stable Times > Volume 3, Issue 1  The quarterly publication of the Stable Value Investment Association First Quarter 1999 • Volume 3 Issue 1 Stable Value: Marching into the New MillenniumBy Randy Myers The stable value industry approaches the new millennium at a crossroads. In just four years, from year-end 1993 to year-end 1997, its share of defined-contribution plan assets shrank from 27 percent to 13.6 percent, according to the William M. Mercer Inc. Survey on Employee Savings Plans. Among only those plans that offered stable value funds, its share dwindled from 54 percent to 27 percent. These declines mirror America's transformation from a nation of savers into a nation of investors, almost all of them, it seems, entranced by a seemingly invincible stock market, and increasingly immune to the charms of a product whose foremost attribute is capital preservation. Yet many leaders in the stable value industry remain surprisingly upbeat heading into the 21st century. "I'm very, very confident that stable value has a future in defined contribution plans," asserts SVIA board member Robert Krebs, director of pension services at NISA Investment Advisors in St. Louis. Adds Bill Gardner, SVIA chair-elect and senior vice president of Dwight Asset Management in Burlington, Vermont, "The next few years will offer us a very exciting growth opportunity." Pollyannas peering through rose-colored glasses? Perhaps not. In an informal survey conducted by Stable Times, Krebs, Gardner and 10 other SVIA members cite good reason to be optimistic. Over the next several years, they argue, the stable value industry gradually will be transformed and strengthened by shifting demographics at home, new opportunities abroad, a recently launched foray into the Individual Retirement Market, and an ever-broadening definition of stable value investing. "Stable value is getting mainstreamed," says Klaus Shigley, chair of the SVIA's data research committee and vice president of risk management for the guaranteed and stable value products division of John Hancock Mutual Life Insurance Co. in Boston. "It's beginning to look more like a generic fixed-income option." But the SVIA members also see plenty of challenges: in promoting stable value products, in embracing new investment strategies without sacrificing product stability, and in attracting a new generation of investors who've never seen the stock market go down for more than a few months. Here's what those board members think the stable value industry might encounter, and how it might respond, in the years ahead: Domestic Growth: Tapping into the Boomer Generation This year, the first of 76 million baby boomers born between 1946 and 1964 turns 53 years of age. As this wave of aging Americans closes in on retirement, we can look for them to rethink their asset allocation policies, putting a greater emphasis on protecting their principal and less emphasis on earning outsized returns. When that happens, the stable value industry should be able to capitalize on their newfound conservatism. "Stable value will be very popular with people who want to diversify out of equities," predicts David Wray, president of the Profit-Sharing Council of America. "Bonds are every bit as volatile as stocks, and bond funds especially have a great deal of volatility, so they're not the solution for investors who want to preserve principal. I think stable value funds will take more and more market share away from bonds funds and money market funds." The industry is already preparing for this shift by making its first tentative forays into the IRA arena. (See "Breaking into the IRA Market) "The vast majority of the money in IRAs comes from rollovers from other plans, not from people contributing $2,000 a year to their account," observes Wray. "That's why the IRA market is so critical, and that's why I think you'll see many more stable value funds introduced for that market in the years ahead." Take that trend to its logical conclusion, and we'll eventually see stable value funds migrating into the retail market at large. To date, of course, nobody has been audacious enough to come out with such a product. That's because nobody knows how frequently retail investors might trade in and out of such funds into money market funds, particularly as interest rates fluctuate. But some industry insiders think the progression is inevitable. "It's going to be some time before it happens, because of concerns about disintermediation (interest-rate arbitrage)," says Ken Walker, president of T. Rowe Price Stable Asset Management Inc. in Richmond, Virginia. "Funds developed to date for the IRA market have early redemption or surrender fees that apply in certain market conditions to offset withdrawal risk. In the retail market, that's not customary. We've just got to find a way to meet halfway between those two extremes. Once that nut is cracked, the game changes." While the industry is excited about new products, it doesn't see them as the only future engine of growth. "Last year, the stock market gave us the first real test in some time of how extreme volatility in the capital markets might impact the way DC-plan participants allocate their assets," observes Patrick Boyle, senior vice president in the Stable Value Group at New York Life. "And what we saw during the third quarter was a tremendous upsurge in demand for stable value products-about three times the norm, based on the amount of business we were asked to quote on. This shows us how it's going to be different going forward. It won't be just a bear market that sends dollars flying into stable value. High volatility may be enough to get people to reassess their asset-allocation decisions. Even a market that goes sideways for five or six quarters may be enough to create significant reallocation momentum into stable value products." International Markets: Into the Vast Unknown And what about stable value outside the U.S.? After all, this is a product born and bred on U.S. soil. Will it work overseas? "One of the inevitabilities is that stable value is going to go international," says David Fallow, an executive vice president with Principal Capital Management, a unit of the Principal Financial Group. "There are several factors that will allow it to grow in overseas markets, including the aging population, particularly in developed countries, where birth rates have gone down. Another driver will be the movement away from defined-benefit plans outside the U.S. in favor of defined contribution plans, a trend that is just starting to gather momentum." "Certainly there will be some marketing hurdles," adds Michael Wyatt, portfolio manager, savings plans, for the Dupont Pension Fund. "Each country has different regulatory and legal issues, and, in many cases, an investor population with different perspectives about what's appropriate to include in an employee savings plan. But I foresee that in the years ahead, international markets will be a potential growth area for stable value as an asset class." Just don't expect foreign financial heavyweights to stay out of the fray. "Today, we already have foreign banks with branches in the U.S. issuing (stable value) products here," says attorney Al Turco, a partner with Turco & Mercier in Manchester, Connecticut, just outside Hartford. "Even as U.S. banks and insurers seek to establish a beachhead outside the U.S., the day may come when we have foreign banks issuing products here directly. It may require some breaking down of legal and other barriers, but we're going to end up with much more global interaction between buyers and sellers of stable value products." Going Mainstream: Pushing the Boundaries of Stable Value Investing As interesting as where stable value is going is what it will look like when it gets there. The range of investments underlying stable value products has broadened dramatically over the past decade with the introduction of synthetic GICs, and industry insiders look for that range to be stretched even further in the decade ahead. "Ultimately, stable value will view itself as a fixed-income (investment) option, and all the investments in the conservative fixed-income world will be available for stable value funds," predicts Vicky Paradis, a vice president in the stable value group at Pacific Investment Management Co. in Newport Beach, California. "In addition, all the investment techniques we're familiar with in the pension world will be available. The result will be better diversification, improved returns, less risk, and more flexibility." To date, managers of synthetic GICs have invested predominantly in high-quality corporate securities, but some have already begun to add high-yield bonds and non-dollar debt to their portfolios in an effort to enhance yields while diversifying credit risk. A number of industry leaders warn against becoming too yield-hungry. "One of the challenges for this very traditional industry," says Rudy Gernert, president of Diversified Financial Products, a division of AEGON USA, in Louisville, Kentucky, "is to continue to refine and create products, to innovate where we can, but also not to do things which take a very simple, straightforward, and, I think, healthy product, and stretch it in ways that it wasn't intended to be stretched. Buyers of stable value products are looking for preservation of capital and a consistent, reasonable rate of return over time. This product, by definition, is not intended to be overly sexy." But the innovation train is hard to stop when it's built up a head of steam. "Over time, we may see more stable value funds hold equities. Right now, only a handful do," says Dupont's Wyatt. "Remember, safety is a relative term. At one time, traditional GICs were considered ultra safe, but after a few insurance company failures, that perception was changed. I'm not saying I see equities becoming a significant portion of stable value, but that there may be a place for them." "A small percentage of equities as a kind of kicker to stable value yields? I could see that evolve in a retail environment," agrees T. Rowe Price's Walker. "It is no different from some of the retail fixed income asset allocation funds which include equity income funds to provide the "kicker." As stable value managers begin to invest synthetics portfolios more aggressively, industry leaders suggest buyers and underwriters take a balanced and long-term perspective. "I'm cautious about including highly volatile securities in stable value products, from a buyer's perspective," says Gernert. "We can't forget the long-term history of the financial markets, and extrapolate based on the last five years of tremendous results. I'm more excited about the application of the stable value concept and opportunity in new markets than I am about trying to alter the core tenets of stable value investments." Count on tomorrow's broader investment guidelines to further the push for a standardized performance measure for stable value products. "Today, if a plan sponsor wants to evaluate a GIC manager, it's very difficult," says John Hancock's Shigley. "It's impossible to do it based on the book value returns that the participant sees. To really measure performance of a stable value fund, we have no choice but to adopt a total return framework similar to what is used in any other asset class." When might that happen? "The SVIA board has already drafted a market-value performance measurement methodology to be shared with members this spring," Shigley reports. "But I would guess it will be another year or two until we have a methodology that secures the board's full endorsement." Resolving the performance measurement dilemma is important to expanding stable value's base in employer-sponsored pension programs and equally important to the millions of individual plan participants in those plans. "If you're a participant in a 401(k) plan, you can look in the newspaper to see how your mutual funds are doing," says SVIA Chair John Milberg, senior vice president, institutional products, for Pacific Life Insurance Co. in Newport Beach, California. "But how is your stable value fund doing? Most participants don't have a clue. That's one of the challenges for the industry and the association, and it's one of the reasons why this whole issue of performance measurement is a key challenge." Poised for Takeoff? With expectations of growing domestic demand for its goods, increased flexibility in developing new products and investment strategies, the potential for expansion overseas, and work already begun on solving the performance measurement dilemma, is the stable value industry truly poised for takeoff as it approaches the new millennium? Not totally. "We still have a long way to go in terms of getting people to think about stable value as an investment option," says Milberg. "It's not as well known as it needs to be, and the challenge for the industry is to promote it and get people to understand its very beneficial characteristics. "Nobody really knows what the future is going to hold," Milberg concludes. "But I find it hard to believe that there won't be a continuation of existing trends, particularly the trend toward giving people more responsibility for investing for retirement. They will have tools at hand that are very simple to use. They can already move funds around at a moment's notice, and check their investment returns every night. It's going to be up to our industry to make sure that stable value products are incorporated into that picture."
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