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Taking Stable Value Overseas: Evaluating the Opportunity

Transferring its domestic success to overseas markets remains an alluring proposition for the stable value industry, according to Robert McCormish, President and Chief Executive Officer of Certus Asset Advisors, a subsidiary of Mellon Financial Corp. He warns, however, that it will be a difficult and expensive undertaking.

"You can't go there alone," McCormish told attendees at the SVIA Forum. "The industry really needs to go en masse."

That said, there are compelling reasons to venture overseas, McCormish conceded. For starters, he projects that the stable value industry will enjoy only flat to negative growth in the U.S. in the years ahead, partly because the baby boomer generation will soon start to retire in earnest. The first boomers turned 55 this year, and as they leave the work force they'll begin to draw down the assets they've accumulated in 401(k) plans and other defined-contribution retirement accounts, including the approximately 23% of that money now held in stable value funds. In many cases, they're also likely to roll retirement assets into Individual Retirement Accounts, where stable value funds are a relatively rare commodity.

While this makes the notion of finding new revenue sources overseas appealing, it could be some time before traditional stable value funds establish any sort of beachhead on foreign shores. Even in Japan and the United Kingdom, where market dynamics are most similar to those in the U.S., accounting and cultural barriers must be overcome before retirement investors are likely to embrace the products.

"Nationalism and protectionism are two of the hurdles to breaking into these markets," added Guy Hudson, director of sales, marketing and product development for Mellon Institutional Asset Management, the umbrella organization for Mellon Financial's asset management business. "In France, for example, 68% of investment assets are in fixed-income securities, which should be favorable for the stable value industry, and 80% of the population believes that their current pension providers will not be able to provide for them in 10 to 15 years. But the French are also reluctant to allow external advisors for their fixed-income funds. And if you look at Europe on the whole, you find there are 15 different states but many more cultures. You find legal and regulatory barriers to entry, and a currency, the euro, that is still very immature. Finally, you find that banks are the major distributors of mutual funds, which has negative implications for U.S. stable value providers unless they are affiliated with one of the gorilla global financial services firms."

Despite all that, Hudson concedes the opportunity abroad is too big to ignore. "Although Europe is shifting to an equity culture more in line with what we already have in the U.S., investors there still put significant amounts of their money into loans and bonds," Hudson said. "This suggests they would be receptive to the benefits that stable value products have to offer. However, you've got to know the market, and you can't go in with a one-size-fits-all model."

McCormish said the stable value industry’s most immediate opportunity lies in the European medium-term note (EMTN) market. More than 15 U.S. insurers are already active in that market, led by AIG SunAmerica. Market-wide issuance of new product is expected to top $20 billion next year, and total outstanding issuance could reach as high as $100 billion within the next few years. Customers for the notes are principally institutional investors in Europe, Japan and Australia.

Stable value vendors can also search for creative ways to use stable value products to meet overseas needs, McCormish said, as his firm did when it created a ¥7 billion (approximately $58 million) dynamically hedged stable value fund for the Japanese market. The fund was an offshoot of a stable value product that had been using U.S. bonds as the base investment. Certus developed and launched the Japanese fund using stable value products as the base investment so that Japanese defined benefit plans could take advantage of book value accounting. The fund is denominated in yen but does not employ a full currency hedge, which would have erased the yield advantage of U.S. versus Japanese fixed income investments. Instead, it seeks to take advantage of active currency management. This allows investors to enjoy upside potential from the currency hedge, McCormish said, plus a base return from the underlying stable value product.

Launching the closed-end fund required the use of an offshore trust. Certus was able to use one that had already been established in Dublin, Ireland, by an affiliate of its parent company. In McCormish's view, any company venturing overseas should have a similar on-ground presence outside the U.S. Even with the help it had, he noted, Certus had some trouble communicating its message to its intended customers. And despite its success in getting the product off the ground, McCormish said Certus won't consider the Japanese fund a successful deal unless it is renewed upon expiration in July 2003.

In addition to seeking an on-ground partner, McCormish recommended that firms venturing overseas think carefully about their own capabilities and the needs of their prospective clients before attempting a deal.

"You have to ask what the investors are interested in, and if you don't know, you can't put together a product that will succeed," he warned.

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