Stable Value Investment Association - Stable Times

Academic study sheds new light on the importance of stable value to defined contribution plan portfolios

Stable value has been a mainstay investment in qualified retirement plans since even before the introduction of 401(k) plans. Stable value continues to be a popular fixed income option within many defined contribution (DC) plans even as regulators focus on the benefits of equity-focused asset allocation strategies such as target-date funds.

But what is the role of an investment that pairs the power of principal preservation with the return of intermediate-term bonds in a world focused on building a nest egg for retirement? Has stable value become somehow less important as the retirement industry adapts to the DC plan's newfound role as the primary pension plan for millions of Americans?

Today stable value accounts for $413 billion in retirement plan assets. Despite stable value's importance to investors, it remains an understudied asset class within the DC arena. Intuitively, many in the financial services industry have long been aware of the important role stable value can play in portfolio asset allocation. But until now, rigorous study of the appropriate role of this asset class has been light.

To address this academic knowledge gap, the Stable Value Investment Association sponsored an independent research study conducted by Professors David Babbel, PhD and Miguel Herce, PhD. Dr. Babbel is a Professor of Insurance and Finance at the Wharton School at the University of Pennsylvania and a Vice President and Senior Advisor at Charles River Associates International (CRAI). Prior to joining CRAI, Dr. Herce served as a Professor of Econometrics at the University of North Carolina at Chapel Hill.

The study examines the risks and net returns of various assets. Stable value net returns were developed from data supplied by 12 stable value managers who manage commingled funds, separate accounts, and full-service funds representing $189 billion in assets. The study looked at stable value funds over the period of time beginning in January 1989 and ending in December 2006. The result of this work is the academic research paper A Closer Look at Stable Value Funds' Performance – the first rigorous analysis of stable value from an investor's point of view. The conclusions of this analysis are compelling – by enabling greater returns for a given level of risk, stable value greatly enhances the likelihood of DC plan participants meeting their retirement goals.

Since the inception of the contemporary stable value fund almost 35 years ago, stable value funds have provided attractive fixed income returns with very low volatility. As a result, DC plan participants have come to rely upon stable value to protect assets from the risk of loss, diversify their portfolios, and blunt the risk of higher volatility investments like stock funds. But are these appropriate uses of stable value?

A Closer Look at Stable Value Funds' Performanceclosely evaluates stable value from an investor's point of view. It carefully compares stable value performance to other common investment alternatives such as U.S. large and small stocks, long-term government and corporate bonds, intermediate bonds, and money market investments.

Before the release of this study, plan providers debated the relative merits of offering stable value versus other fixed income options such as money market funds or intermediate bonds. Now, through state-of-the-art statistical techniques such as mean-variance analysis, stochastic dominance analysis, and multi-period utility analysis, the answer is clear. Offering stable value as the core fixed income option in a DC line-up provides a significant benefit to plan participants. By delivering investment performance characteristic of intermediate bonds with money market-like stability, stable value provides superior return per unit of risk. As illustrated in the diagram above, stable value shifts the efficient frontier leftward, outperforms money market funds over time and in nearly all market conditions, and provides a better risk-adjusted return than intermediate bonds over time and in nearly all market conditions.

As a result, stable value plays an important role in a portfolio context. It allows plan participants to increase the return on their portfolios for any given level of risk or decrease the risk of their portfolio for any level of return. This finding has important implications for asset allocation strategies such as target date and target risk. The central reason for using a target-date or a target-risk fund is to effectively tailor participants' asset allocation to an appropriate measure of risk tolerance. The wisdom of such an approach is beyond question. Since stable value favorably shifts the efficient frontier, it naturally follows that it should serve as an important part of all targe- date and target-risk strategies that include a fixed income component.

"The point isn't that investors should shun equities entirely but rather that if they are combining them with other assets to build a diversified portfolio, those other assets should be stable value funds. They provide investors with a whole different way of planning for the future," says Professor David Babbel.

Using Stable Value in Retirement: The Power of Staying in a Qualified Plan

Stable value also serves as a powerful investment option in an individual's retirement years, providing steady, predictable income while insulating a portfolio from the shock of a market correction that could dramatically reduce a retiree's nest egg.

As such, stable value has an important role to play in meeting a retiree's need for steady income during retirement. Participants that elect to roll out of their DC plan lose two important advantages: access to stable value funds and institutional pricing. The high fees often associated with retail investing are detrimental to participants who rollover their DC plan balances to IRAs. The availability and performance of stable value provides another compelling reason for participants to keep their money in a DC plan.

A Closer Look at Stable Value Funds Performance: A Quick Summary