A Consultant’s View on Defined Contribution Plans and Stable Value

By Randy Myers


Target-date funds are capturing an increasing share of the assets in defined contribution retirement plans. But Jacob Punnoose, a Partner in Aon Hewitt Investment Consulting, says the future remains bright for stable value funds, too.

Speaking at the 2016 SVIA Fall Forum, Punnoose said that even if stable value’s share of the defined contribution marketplace continues to moderate, the ongoing creation of new plans and the continued flow of new money into existing plans means there is still a lot of opportunity for stable value over the near-to-intermediate term.

Longer term, Punnoose said, stable value providers will need to find a way to have their product included in target-date funds, which have become the predominant default investment option at companies that automatically enroll eligible employees into their plans. The easiest way to do that, he said, will be to promote the use of custom target-date funds that can easily incorporate a stable value component into their investment mix. But “easy” may understate the task.

“It’s going to be an uphill challenge in terms of converting plans using off-the-shelf target-date funds to custom funds,” said Punnoose “By and large, it is the larger plan sponsors who are more amenable to it. Smaller plan sponsors are reasonably happy with off-the-shelf target-date funds, even if there is the potential for more alpha and more asset-class diversification with custom funds.”

One arrow in the stable value industry’s quiver, Punnoose noted, is that its product serves a true purpose in defined contribution plans. “When we talk with our plan sponsors about the different investment options and investment structures they want in their DC plans, there are a lot of differing opinions. But one common element across almost every plan sponsor we talk to is that they want a stable net-asset-value product. That would be either a money market fund or a stable value fund. And given that stable value has outperformed money market over long periods of time with similar levels of risk, it is not surprising that a majority of plan sponsors use stable value funds.”

Punnoose said stable value also could benefit from a relatively new trend to reduce the number of investment options within defined contribution plans. In consulting with plan sponsor clients, he said, Aon Hewitt often promotes the benefits of adopting a streamlined investment menu. Such a menu might include a suite of target-date funds along with four core stand-alone funds: a growth fund, an income fund, an inflation fund and a capital preservation fund. “In that construct, where you’re reducing the number of options, the relative importance of stable value increases,” he said. “It now becomes one of perhaps four non-target-date funds. So there might be more attention paid to each of those individual options.”

Elsewhere, Punnoose documented a number of developments favorable for stable value funds, and others that are worrisome, like the growing incidence of lawsuits targeting stable value funds. The lawsuits allege a diverse range of missteps, from overly conservative to overly aggressive investment management.

Among the positive developments, Punnoose said, are the significant increase in stable value wrap capacity in recent years, and recent rule changes imposing increased transparency and reporting requirements on institutional prime money market funds. Those rule changes are driving some retirement plans to offer stable value funds instead of money market funds. Among plans served by Aon Hewitt, Punnoose observed, 40 percent offered money market funds in 2015, down from 50 percent a decade earlier. During that same period, the percentage of plans offering stable value funds rose to 74 percent from 66 percent.

Punnoose sees potential for significant additional flows of money away from money market funds and into stable value. Where plans have not moved to stable value so far, he said, common stumbling blocks include concerns about future wrap capacity and about employer-initiated events that could put book-value withdrawals in jeopardy, at least temporarily. And some plans, he said, simply find it easier to switch from a prime money market fund to a government fund that is not subject to the new regulations.

In plans that do offer stable value, Punnoose said, the percentage of plan assets allocated to stable value has edged lower over the past 10 years. This is a consequence in part of the bull market in equities, and of the growing popularity of target-date funds as a default investment option for participants who are enrolled in their plans automatically.

The keys to growing the stable value market in the years ahead will include promoting the use of stable value in target-date funds and ensuring that the consulting industry understands the product. Consultants who understand stable value, he said, are more likely to recommend it to their plan sponsor clients and to accentuate the positives of stable value relative to money market funds.

Punnoose said the stable value industry also will want to emphasize the role stable value can play in helping retirement plan participants meet their income goals in retirement, make stable value less operationally complex for plan sponsors, make stable value vehicles available to very small plans, ensure that book value accounting for stable value funds continues to be accepted, and look for growth in the 403(b) retirement plan market and internationally.