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Pooled Funds Subtly Changing their Characteristics

Pooled funds are becoming an increasingly popular investment vehicle for Stable Value investors. Hueler Analytics reports that the pooled funds it tracks had total assets of $63.4 billion at mid-year, up from $32.7 billion as recently as June 30, 1999.

Pooled Stable Value funds accept investments from multiple investors, typically retirement plans, and manage a portfolio of GICs and/or wrapped bonds on their behalf. In response to changing market conditions over the past several years-primarily the long downtrend in interest rates-they have made subtle changes to their investment portfolios. Those changes are centered on how much cash they hold to meet liquidity needs, the degree to which they have embraced wrapped bonds at the expense of traditional GICs in their investment portfolios, and their use of participating wrap contracts to back their fund's book-value guarantee to investors.

Kathleen Schillo, Director of Data and Research at Hueler, says the average pooled Stable Value fund in its universe held six percent of its assets in cash or cash equivalents at mid-year, down from nine percent six years earlier. Speaking at the SVIA's 2003 National Forum, Schillo attributed the decline in part to the increased use of global wrap contracts, which provide additional liquidity. Laura Dagan, Chief Operating Officer with Dwight Asset Management added that in the current low rate environment, portfolio performance is penalized by large allocations to cash. Accordingly, she said, "managers will keep that allocation as skinny as possible while still staying on top of their liquidity needs." Dagan and other Stable Value managers at the forum indicated they believe pooled funds are sufficiently prepared to meet liquidity needs.

Fund managers also have increased their use of participating ("par") wrap contracts to back the book-value guarantee their funds offer to investors. With a par contract, the funds, and, as a consequence, their investors share some of cash flow risks with the wrap issuer. At June 30, Schillo said, par contracts accounted for 63 percent of the contracts in the Hueler Universe, up from 57 percent at June 30, 1997. Non-par contracts had just a 24 percent share of the market, down from 39 percent six years earlier, while par/non-par hybrids had captured a 12 percent market share, up from four percent.

Pooled funds have exhibited a declining appetite for holding traditional GICs in their portfolios. At June 30, they accounted for just 15 percent of the holdings in the Hueler Universe, down from 32 percent at June 30, 1997. While the percentage of GICs has declined, the total dollar amount in the universe has remained about $9.5 billion over the past six years. Schillo also noted that an informal survey of 15 Stable Value managers by Hueler found that 14 managers plan to continue to evaluate GICs on a relative value basis and do not have plans to eliminate traditional GICs from their portfolios entirely. Rather, they said, they will continue to hold them as a core holding, with allocation targets ranging as high as 30 percent.

The subtle portfolio changes pooled funds have embraced have not cooled investor ardor for them. With interest rates on money market funds now as low as one percent or less-and crediting rates on Stable Value funds still hovering in the neighborhood of five percent-Steve Ferber, Senior Vice President of Sales and Marketing for Stable Value Manager Gartmore Morley Financial Services, told the forum audience that his company has been inundated by queries from potential new clients. "We are seeing other funds calling us and we are seeing many large and small plan sponsors calling us," Ferber said. But like other Stable Value managers, he said his company is being cautious not to take in so-called "hot money" that would likely flee Stable Value the first time rates on money funds become competitive again or the stock market looks more appealing. "We carefully evaluate each potential customer and consider their needs, their fit with us, and what impact their investment would have on our existing investors," Ferber said.

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