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Stable Value Finding a Home in Increasing Popular Lifestyle Funds

Lifestyle funds are becoming popular investment options in defined contribution plans, presenting new opportunities for the stable value community to reach and help U.S. workers saving for retirement.

A lifestyle fund is a "fund of funds" designed to make it easier for investors to build a diversified investment portfolio using just one investment option. Fund companies marketing them usually offer a series of lifestyle funds, with each fund in the series distinguished by its risk profile. In some fund families, the portfolios are static, meaning the risk profiles never change. Investors might be able to choose from, say, an aggressive fund, a moderate fund, a conservative fund and an income fund, each featuring a progressively smaller allocation to equities. Other fund families offer lifestyle funds targeted to specific retirement dates, and they gradually alter the asset allocation mix in each fund as the target date approaches. The idea is to avoid making investors calculate their risk profile or change funds as that profile changes. Instead, investors are encouraged to simply choose the lifestyle fund that most closely matches the year they expect to retire and hold it in perpetuity.

Addressing the SVIA Forum, Anne Lester, a Vice President and Portfolio Manager with JPMorgan Fleming Asset Management, said asset allocation funds such as lifestyle funds are now offered in more than 50 percent of the 401(k) plans tracked by Hewitt Associates, and where available are used by more than 33 percent of participants.

Brian Murphy of AEGON Institutional Markets added that stable value funds are strong alternatives to cash (money market funds) or fixed income (bond funds) in a lifestyle fund. Historically, stable value funds have provided higher returns than money market funds (similar to bond funds), but have exhibited lower volatility than bond funds (similar to money market funds). And, of course, they feature a book-value guarantee that protects investors' principal. Murphy noted that because a majority of defined contribution plans already offer a stable value option, most plan sponsors shopping for lifestyle funds to add to their investment lineup will already be familiar with stable value's unique benefits.

Telecommunications company Qwest is already sold; it is among the many plan sponsors already offering lifestyle funds to its plan participants, and it includes a stable value component in two of its three-lifestyle offerings. Don Butt, who oversees the company's $2.9 billion 401(k) plan, says it includes three tiers of investment options: three risk-based lifestyle funds (conservative, moderate and aggressive), six core individual asset class funds, and a brokerage account. Plan participants have allocated 26 percent of their plan's assets to the lifestyle funds, which feature static asset allocations.

Qwest's conservative lifestyle fund has 30 percent of its assets allocated to stable value, 30 percent to bonds, and 40 percent to equities. The moderate fund has a 10 percent allocation to stable value, 30 percent to bonds, and 60 percent to equities. This fund also serves as the default option in the plan for participants who do not choose their own investment options. The aggressive fund has no stable value component, allocating 20 percent of assets to bonds and the remainder to equities.

Lester and Butt agreed that the biggest challenge to including stable value in lifestyle funds is figuring out how big the stable value slice should be. Because stable value's returns are so smooth, portfolio optimization models tend to recommend extraordinarily high allocations to it. Despite the low volatility exhibited by stable value funds, it can be difficult to develop the forward-looking assumptions and correlations needed for optimization models. For example, stable value will outperform cash in a falling interest rate environment, but under perform bonds in the same environment. Conversely, stable value can under perform both cash and bonds in certain rising rate environments.

The upshot is that firms creating lifestyle funds must make informed but ultimately subjective decisions about how much stable value to include. "It is," Lester allowed, "more art than science."

At Qwest, Butt said he and his colleagues overseeing the company's 401(k) plan took into account the results of portfolio optimization modeling and the recommendations of outside vendors, and also looked at how other plan sponsors and mutual fund managers were using stable value in their lifestyle funds, to come up with its asset allocation strategy. It reevaluates the asset allocation mix annually, and rebalances the lifestyle portfolios monthly whenever their actual asset allocation varies from the target by more than one percent.

For plan sponsors contemplating including stable value funds in a lifecycle portfolio, Lester said, key considerations include deciding whether stable value should replace what would otherwise be the cash allocation or the fixed income allocation, or both. Other practical concerns center on custody issues, fund accounting and cash flows, all of which can come into play when buying or selling additional stable value assets to keep the lifestyle fund at its targeted asset allocation mix. Finally, Lester noted that if a sponsor wants its lifestyle funds to use mutual funds as their core underlying investments, it could be difficult to include a stable value component since most stable value mutual funds have disappeared. It would be simpler, she explained, to use underlying investments that are all of the same structural type-all commingled or pooled funds, for example. While it would be possible to mix mutual funds and a pooled stable value fund in the same lifestyle fund, she said, recordkeeping would be more complex.

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