By Randy Myers
Stable value funds invest predominantly in short- to medium-term fixed income securities. Now, researchers at Vanguard Group are looking into whether a stable value fund invested in a mix of stocks and bonds, and incorporated into a target-date fund, might offer advantages to target-date investors.
“The idea, quite simply, is trying to combine multi-asset investments in a stable value wrapper and then put it inside a target-date fund,” said Vanguard’s Ankul Daga in a presentation to attendees at the 2023 SVIA Fall Forum. “We think this idea has legs … and invite you to have a conversation with us about it.”
Daga is a researcher in the goal-based investing team in Vanguard Investment Management Group. He views having a multi-asset stable value fund (MASVF) in a target-date fund as a way to transition between the accumulation and decumulation phases of retirement planning. He cautions, however, that the idea is still very much in the research stage.
“We typically look at any idea in three phases,” Daga explained. “We look at the investment case, which is—does it add value to the end investor? We stress test that investment case … and then look at the product case—is this product really feasible? Is there capacity for the solution? Finally, we look at the business case—is there demand for the solution, and can the solution be brought to market at a price point which would be beneficial to the end investor?”
Early research suggests that such a product could add value for investors, Daga said. Vanguard has modeled the concept, comparing median wealth outcomes and probabilities of success for a traditionally structured target-date fund and for that same fund with an MASVF added to its portfolio. On both scores, the fund with the MASVF sleeve outperformed the traditional fund. Beginning in an investor’s late 70s, it delivered higher median wealth outcomes and probabilities of success, with the size of that benefit growing steadily as the investor got even older.
Vanguard experimented with a range of variables in conducting its analysis, varying the age at which an investor would begin incorporating an MASVF sleeve into their target-date fund, the size of that sleeve relative to other assets, and the ratio of stocks to bonds in the MASVF itself. It settled on a base case that adds the sleeve to the target-date fund when the investor is age 55, with the sleeve accounting for 25 percent of total fund assets. The base case also assumes the MASVF has 80% of its assets invested in U.S. fixed income and 20% in U.S. equities, and that gains and losses within the MASVF are amortized over a period of four years.
As might be expected, Daga said, Vanguard’s research shows that higher allocations to equities within the MASVF, and higher allocations to the MASVF within the target date fund, lead to better outcomes for investors. (Daga and his team modeled equity allocations ranging from 10% to 70%, and MASVF allocations ranging from 10% to 40% allocation.)
Vanguard found limited additional benefit to introducing the MASVF into the target-date fund before an investor turns 55, and saw the benefit shrink when introducing it after age 55. It modeled outcomes under 10,000 different market scenarios and found that the MASVF yielded value even in stressed markets. Vanguard tested the solution in adverse equity market scenarios followed by outflows or withdrawals from the solution.
Still to be answered, of course, is the question of whether such a product could be introduced at a price acceptable to investors and still profitable for a provider. Vanguard has tried to answer that question by calculating a certainty fee equivalent (CFE) for the product. The CFE can be thought of as the additional fee an investor would be willing to pay to invest in an improved solution (e.g., a target-date fund with an MASVF) relative to a reference solution (e.g., the current target-date fund).
Under the base case (a 20% allocation to stocks), the CFE equaled 21 basis points. But here again, Vanguard modeled various scenarios. As the allocation to equities within the MASVF rose from 10% to 70%, the corresponding CFE rose from 15 basis points to 45 basis points.
“The key thing here is that the intuition holds up,” Daga said. “The more equities you wrap, the more peace of mind and benefit the end investor gets.”
Daga concluded his presentation by inviting members of the SVIA community to weigh in on adding MASVFs to target date funds.
“Given this is a new innovative solution,” he said, “it’s really important to make sure that we take our peers along, get challenges from our partners, (and) make sure we’re all comfortable with it so that we can then go out and educate consultants, educate plan sponsors, and educate the end participant, who is the ultimate beneficiary of all of this work.”