By Randy Myers
- Eric Baumhoff, Chief Investment Officer, Standish Mellon
- James Corning, Director, Stable Value Solutions, TIAA-CREF
- Shane Johnston, Senior Portfolio Manager, Morley Financial Services
- Robert Madore, Vice President, T.Rowe Price Associates, Inc.
Moderator: Karl Tourville, Founding Managing Partner and President, Executive Operating Committee Chairman, Galliard Capital Management
Few external factors impact stable value funds more than changes in interest rates. With Treasury yields approximately 75 to 100 basis points higher in late April than they were at their 2016 lows, many retirement plan sponsors were wondering what it means for their stable value funds. They were concerned not only about the impact on returns, but also about the impact on market- value-to-book-value ratios of the stable value contracts.
This topic held center stage at the 2017 SVIA Spring Seminar during a panel discussion on challenges and opportunities facing the stable value industry.
Eric Baumhoff said his firm tries to make sure that clients hear three important things:
- The range of market-to-book ratios plan sponsors have become accustomed to since 2009—about 102 percent to 105 percent—is not the range stable value portfolios traditionally have traded in over longer periods of time.
- The causes behind the current rise in interest rates are more favorable for stable value than they have sometimes been in the past.
- Higher rates ultimately will benefit stable value investors.
Baumhoff said stable value market-to-book ratios historically have ranged between 97 percent and 103 percent. To demonstrate how rising rates are likely to impact these ratios, he said, his firm modelled a synthetic stable value portfolio and tracked the market-to-book ratio for that portfolio over a 25-year period that included the 2004- 2006 period when interest rates rose just over 400 basis points. By the end of the cycle, he said, the ratio had fallen to about 97.5 percent from 102 percent.
Baumhoff also noted that interest rates today are being driven by rising Treasury yields rather than, as was the case in 2008, widening credit spreads. The latter scenario, he said, “is a much different and scarier place than the current environment, in which we’re able to reinvest cash flows at higher yields, which can be beneficial”.
Finally, Baumhoff said, “We want rates to go up, at a measured pace, slowly over time,” he said. “We want rates to normalize. The corollary of that is that market-to-book ratios will come down; you can’t get away from that. But this is no time to panic. We’ve seen scenarios like this over the last 25 years.”
Shane Johnston added that stable value crediting rates—the rates paid out to stable value investors—will lag the uptick in interest rates due to the way crediting rates are calculated. But he stressed that this is the way the product is designed to work; crediting rate formulas smooth out the market value returns of the portfolios, minimizing volatility for investors. Still, he said, over time rising rates push up crediting rates, and that benefits investors. Stable value managers who wish to minimize this lag effect, Johnston noted, can shorten the duration of their portfolios.
Johnston encouraged stable value managers to keep the lines of communication open with plan sponsors and consultants so they understand how a rising rate environment might impact their stable value funds. Historically, he added, stable value funds have enjoyed positive cash flows during such periods.
For Robert Madore, Vice President with investment manager T. Rowe Price Associates, one of the most important questions surrounding a rising rate environment is whether it will impact the amount of wrap capacity available to stable value managers. “We’re blessed today to have plenty of capacity, most of which came online when market values were above book values,” he said. “How much of that is going to be available to us (if rates keep rising)?”
James Corning said his team spends much of its time right now focused on how to expand the use of stable value funds at a time when target- date funds are capturing the lion’s share of new money flowing into retirement savings plans. TIAA isn’t a stable value manager, he pointed out, but it does offer stable value products in the defined contribution savings plans it manages. He said one way it looks to promote the use of stable value is by encouraging its inclusion in custom target-date funds. He said his firm also sees an opportunity for the industry to grow by positioning stable value as a means of generating income for plan participants once they’ve retired.
Panel moderator Karl Tourville reminded seminar participants that the stable value industry has adapted and thrived through many changing environments, and he suggested that now may be its golden age. “The market, at least as we view it, has never been stronger,” he said. “Market-to- book ratios are very good, and we’ve got a strong issuer base that has broadened considerably since 2008.”
Tourville said stable value fees are attractive from the manager and wrap provider perspective, and “probably too attractive in some cases, which we’ll need to address going forward as plan sponsors increasingly focus on total expenses, not just what managers are charging.”
Tourville stressed that he’s not in favor of cutting management fees, but said it’s simply unrealistic to think the stable value industry can be immune to the fee pressures being felt across the retirement plan landscape.
“I agree,” said Madore. “When it comes down to looking at adding stable value to a managed account, for example, what’s your comparison? You look at short-term bond funds. To the extent total fees for stable value are close to or more than the short-duration bond fund, they’re going to pick the bond fund. So, I think we definitely have to worry about fees.”
Johnston countered that it’s important for stable value providers to make it clear that stable value funds offer benefits that short-duration bond funds cannot.
Several of the panelists agreed that one of their biggest concerns right now is the amount of money flowing into and out of stable value funds. Money is flowing out in some cases as retiring baby boomers start consuming retirement plan assets rather than adding to them. Meanwhile, the vast majority of new retirement-plan contributions are flowing into target-date funds, which necessarily limits what’s available for stable value.
Most panelists said they’d seen some money flow into stable value funds as a result of new rules from the Securities and Exchange Commission that have been widely viewed as unfavorable to money market funds. As a consequence, they noted, some plan sponsors have replaced money market funds with stable value alternatives. Still, they said, the amount of money involved wasn’t as great as many had been expecting.
In looking at future opportunities for the stable value industry, the panelists expressed hope that stable value would become viewed more broadly as a source of retirement income, as a component of asset-allocation products such as target-date funds, and as a more common investment option in other markets, including health savings accounts and multiple-employer retirement plans.