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Editor’s Corner

As I returned to my office today, I felt rejuvenated from the exciting action of the “Elite 8”. This weekend's games displayed numerous examples of why you should never give up even when you are down. As we replayed, the end of the Illinois vs. Arizona game for our boys as an example of this important life lesson (and because my wife, who grew up in Chicago, roots for anything from Illinois), I thought this lesson should not be lost on the stable value industry.

While not as intense as being down 14 points with less than 4 minutes to go, stable value has certainly had some nail biting moments for our membership thanks to the accounting spotlight in recent years. Stable value mutual funds were closed, taking away a valuable investment option for individuals outside of an employer-sponsored retirement plan and the hottest growth area the industry has seen in many years. Despite over 30 years of working practice, the AICPA decided to ask FASB for formal guidance on accounting for the bank collective trusts used by most smaller defined contributions.

All of this may feel like we have taken a few body blows, but we are still in much better shape than Illinois was in their game on Saturday night. In fact, we got into the game if you will, when FASB took up the AICPA request for guidance. As you can imagine, the staff, board and committee members of the SVIA have been extremely busy working on accounting issues. Based on the update that was provided in March at the well attended half-day accounting seminar that the SVIA put on in New York City, it is clear that these groups have been having a significant impact. In fact, we may see an exposure draft in June. That's why we need to stay on message and support the SVIA in its continued efforts. FASB's efforts give us an opportunity to get it right and provide the clarity that the accounts want.

Going beyond accounting, some people in the industry have pointed to other potential storms forming on the horizon. The Federal Reserve has raised the Federal Funds target by 175 basis points to 2.75%. As a result, yields on money market funds have increased dramatically since their close encounter with 0%. In addition, this increase in the short rates has, until very recently (can anyone say “conundrum?”) not been matched by similar rate increases further out the curve (the yield curve between 2 years and 5-years has fallen 100 basis points in the last year to 40 basis points). Therefore stable value returns have not turned up (in fact many funds may still be seeing declining returns) yet and the return advantage of stable value has diminished.

While I have to admit that showing a 4%+ return advantage versus money market funds was fun in 2003, we should not lose sight of the bigger picture. Five year treasury yields are still 1.4% higher than 1 month LIBOR (a good money market proxy). Over the last 20-years, this spread has averaged .92%, so the current spread is still above average. Even if the Federal Reserve eventually pushes the Fed Funds rate to 4.5%, this is still lower than the current net crediting rates for our clients. As it looks like intermediate rates are finally starting to rise, crediting rates should start moving up.

Some reduction in stable value's advantage over money market rates seems likely. However, based on our forecast (This forecast is hopefully better than my call last year that the Red Sox would not win the World Series. I just wanted to thank my co-editor Steve LeLaurin for reminding me of that, and I will point out that the Cubs, much to my wife's chagrin, did fade in spectacular fashion when crunch time approached.), it is unlikely that our stable value returns will fall below money market funds. In fact, I believe a rising rate environment will actually highlight the true beauty of stable value.

The long term advantage of stable value over money market funds is well established. Rising rates will bring the advantage of stable value versus bond funds to the forefront. More than once in the last year, I have been asked by experienced asset allocation professionals to explain why investors with anything other than a short investment horizon would be willing to pay even the very modest costs of a wrapper contract versus just buying unwrapped bonds. They correctly point out that over very long periods of time the total returns over time will be similar (less the fees).

While this query often comes from sophisticated investors, their primary experience is not in the defined contribution market. Even if most participants do not understand how stable value works, they understand the results. They see higher returns than money market funds and balances that never drop. This is what makes stable value so popular; this is why stable value allocations are significantly higher than bond and money market allocations when the funds are offered side by side.

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