A lot changed in the wake of the financial crisis of 2008, including the way retirement plan sponsors and their advisors think about stable value funds.
“Twenty years ago, clients wanted a fully benefit responsive, competitive yield from their stable value fund, with no onerous restrictions if they wanted to cancel their contract,” observes plan consultant Angelo Auriemma. “Then the financial crisis hit, and their questions, and concerns, started to change.”
Auriemma, director of investment advisory services for Plan Sponsor Advisors LLC, told participants at the SIVA’s 2012 Annual Forum that plan sponsors still care about the yield offered by their stable value fund. In many cases, though, that has become secondary to issues such as transparency, or the ability to see what the fund’s underlying investment portfolio looks like; the liquidity and composition of the investments in that portfolio; how well the fund has diversified its credit risk; the availability of wrap insurance for the fund; the covenants associated with those insurance contracts; and, in pooled stable value funds, the impact of cash flows from other plans within those funds.
Auriemma said his firm continues to recommend to its plan sponsor clients that they offer stable value as an investment option, and that most are receptive to the message. While acknowledging hearing stories about sponsors removing stable value products from their plans in favor of money market funds or other alternatives, he said that’s not what his firm is seeing from most of its clients. “We’re seeing some deterioration in their perception of the product, but they’re not saying, ‘Get me out,’” he said. “They’re saying, ‘Instead of spending 2.5 seconds on this at our quarterly meeting, let’s spend 10 minutes.’ There’s just a heightened awareness of the product, and more questions.” Auriemma said his consulting firm also evaluates stable value products differently today than it did before the financial crisis. It still focuses on the attractiveness of the product relative to money market funds, but it also pays attention to the viability of new product innovations, including stable value alternatives. The firm also applies expanded and re-prioritized selection and monitoring criteria to stable value funds.
In comparison to money market funds, Auriemma said stable value funds continue to offer a meaningful yield differential that is significant to plan sponsors, especially when expressed in terms of opportunity costs. A plan with $20 million in stable value assets yielding as little as 1 percent—well below current average crediting rates—would nonetheless produce $200,000 in annual earnings for plan participants. By contrast, a money market fund yielding .01 percent—not uncommon in today’s environment—would produce just $2,000 in annual earnings. “When you talk about foregone earnings on behalf of participants, sponsors’ eyebrows furrow,” Auriemma said. He noted that even though expenses for stable value funds have gone up since the financial crisis, mostly due to higher wrap fees, sponsors tend to evaluate the funds in terms of their net yield, which continues to be favorable relative to money market funds. He estimated that sponsors would continue to view stable value funds as attractive, relative to money market funds, even if net yields fell as low as 50 basis points.
Auriemma said his firm advises sponsors that a competitive yield should remain an important consideration, but that the duration of the underlying investment portfolio and the credit quality of that portfolio are important, too. While sponsors appear to be tolerant of some interest rate risk, he noted, they seem to have a strong preference for controlling that risk by having shorter-duration portfolios. He said sponsors also show a preference for their stable value funds to hold publicly traded rather than non-public securities, and to stay with the traditional 12-month put option governing plan terminations in pooled funds rather than imposing a multi-year payout. Auriemma said he’s intrigued by some of the stable value alternatives the industry has been considering, including stable net-assetvalue (NAV) products that are built around an insurance-wrapped portfolio of fixed-maturity, fixed-income tranches that amortize over time, and floating-rate NAV products that consist of wrapped and unwrapped portfolios of fixed-income investments. However, he said, he thinks plan sponsors will be slow to warm to them.
Over the next several years, Auriemma said he expects that stable value managers will continue to face elevated reinvestment risk as interest rates remain low, putting continued pressure on stable value crediting rates. He foresees a continued restricted supply of pooled funds and funds eligible for 403(b) retirement savings plans, and a desire among wrap providers to supplement their revenue by demanding a greater share of investment management responsibilities. Still, he concluded, his firm believes stable value will continue to represent a viable asset class for the defined contribution plan marketplace.