Insiders Assess Stable Value Issues

Stable value “insiders” are a diverse lot. Among others, they include stable value asset managers and contract issuers, banks and insurance companies, retirement plan sponsors and retirement plan consultants. All share the same overarching goal of providing consistently positive returns for retirement plan participants, yet each views the asset class from a slightly different perspective. In a wide-ranging panel discussion at the 2012 SVIA Fall Forum, several of them discussed how they view the stable value industry today and pinpointed issues that are top of mind for them.

Maureen Scaduto, plan sponsor

Maureen Scaduto is associate director for the Cultural Institutions Retirement System in New York City, a multi-employer system covering about 10,000 active and 10,000 former employees of cultural institutions and day care centers in the New York City area. In addition to offering a traditional pension plan and a life insurance plan, the organization operates a $400 million 401(k) plan that includes a stable value fund. Perhaps because that plan is the only savings vehicle many of its participants have, Scaduto said, capital preservation is important to them, and they collectively have about 60 percent of their plan assets invested in the stable value option.

Scaduto said that, in hindsight, her organization recognizes that it didn’t understand stable value funds very well prior to the 2008 financial crisis, but she said it has a much better understanding of them today. Among the issues she and her colleagues are paying attention to are the growing complexity of stable value contracts and the tighter investment guidelines being imposed on stable value managers by wrap issuers. They’re also mindful of the amount of wrap capacity available in the marketplace, and concerned about the possibility that wrap issuers may try to lengthen the standard 12-month put option that applies to plan terminations in pooled funds.

They’re concerned, too, she said, about the persistently low interest-rate environment and what that might do to their stable value fund’s market-value- to-book-value ratio and its crediting rate—especially as the crediting-rate cushion provided by prior market-value gains begins to fade away.

William McCloskey, insurer and wrap issuer

As a vice president and head of the Institutional Stable Value business at Prudential Retirement, William McCloskey leads all daily operations of Prudential’s stable value wrap and traditional GIC businesses. Addressing Forum participants, McCloskey said that while the stable value industry has negotiated the post-financial crisis years well it still faces many challenges, which include the continuing need to bring new wrap capacity to the marketplace and managing what looks to be an extended period of low interest rates. Continued low rates, he said, are likely to gradually erode market-value-to-book-value ratios of stable value funds, making them riskier for wrap issuers. “They (low rates) will challenge our ability to guarantee investment strategies we were able to guarantee when market-to-book ratios and interest rates were higher,” he emphasized.

McCloskey said there also remains a need for the stable value industry to do a better job of educating retirement plan sponsors and plan participants about the value proposition that stable value funds offer. “When I see plan sponsors making decisions to get out of stable value,” he said, “I think it reflects a lack of understanding rather than, necessarily, good decision-making.”

Melissa Rowe, bank wrap issuer

Melissa Rowe is a vice president in the Stable Value Group of State Street Bank’s Structured Products Division, where she has responsibility for institutional client  relationship management, including underwriting, pricing and product management. She said one of the biggest challenges facing stable value providers is the growing popularity among plan sponsors of re-enrolling participants in their plans. As part of that process, sponsors often automatically direct future participant contributions into the plan’s qualified default investment alternative, which in many cases is a target-date fund. That can have the effect of increasing cash flows out of the plan’s stable value fund. “We understand why the sponsor is doing something like that, but it becomes an event for the plan and, therefore, for the stable value fund,” Rowe observed.

Rowe said her firm has had experience with two or three sponsors conducting re-enrollments so far in 2012, after not seeing it at all in prior years. “Where it’s happened,” she says, “we’ve been working with sponsors and investment managers to determine how it affects the stable value fund and its long-term viability.”

Adam Silver, bank wrap issuer

As director of the 401(k) Stable Value Group at Royal Bank of Canada, Adam Silver is responsible for the bank’s stable value wrap business. He said that generally speaking, the momentum for the business has been more positive this year than in years past. “Most of the troubled accounts that existed around the industry have been diffused or worked out, and I think  that’s allowed for a little bit more optimism and renewed growth, and that’s good,” he said.

Silver reiterated that the low interest-rate environment, and expectations for continued low rates, will prove challenging for the stable value industry. “It’s accelerated by the fact that everyone wants to position themselves a little shorter down the yield curve, which only amortizes gains away more quickly,” he said. “That puts us in a position where we’re ultimately going to be faced with a rising rate environment, with all the gains long since amortized away. It’s something we’re sensitive to, and looking at closely.”

Silver said he was glad to hear during other sessions at the SVIA Fall Forum that plan sponsors are asking more questions about stable value and getting a better  understanding of the product. He theorized that one of the main reasons sponsors have been frustrated with new requirements handed down by wrap issuers lately is poor communication between sponsors, managers, wrap providers and other parties involved in the product. “The more that people understand the product,” he said, “the better it is for all of us.”

John Axtell, investment manager

As managing director and head of the Stable Value Management Group at DB Advisors in New York, John Axtell is squarely positioned between the interests of plan sponsors and wrap issuers. He described the industry’s overarching challenge right now as one of finding the right tradeoff between wrap issuers’ desire to control risk and plan sponsors’ waning tolerance for the measures wrap issuers are pushing to accomplish that.

By way of example, he noted hearing anecdotally that some wrap issuers are interested in having stable value managers limit the duration of stable value portfolios to as little as three years. “That creates anxiety for us,” he said. “A lot of funds have a significant allocation to the (Barclays) intermediate aggregate (fixed-income) benchmark, which currently has a duration of about 3.4 years and can extend out to four years, and even a little bit in excess of that historically. My perception is that there is a pretty strong preference among plan sponsors and their consultants to keep that intermediate allocation and not bring the duration for the whole portfolio down below three years.”

The reason, he said, is clear: the intermediate aggregate index historically has offered a return advantage over benchmarks with shorter durations. He said his firm modeled returns going back 10 years for a wrapped version of the intermediate aggregate index and the Stable Income Market Index, which has a duration of about 2.5 years. Over that time period, he said, the returns for a wrapped intermediate aggregate index exceeded those for the SIMI by about 50 basis points per year. Today, he said, the yield advantage remains about the same.

Axtell said sticking with a longer-duration benchmark offers other advantages, too, such as being able to provide better diversification through a larger universe of  investable securities, and perhaps having access to more supply further out on the yield curve, since so much demand is currently concentrated at the shorter-end of the curve. “And, I think, plan sponsors and investment consultants have a perception there is more opportunity for a manager to add value by having the latitude of, for example, an intermediate aggregate versus a shorter strategy,” he said. Continued pressure on this front, he predicted, could test the tolerance sponsors have for more changes in stable value funds.

Axtell also echoed the idea that the stable value industry should come together to produce educational materials for retirement plan participants explaining the benefits of stable value products.

Tony Luna, investment manager

Tony Luna is a vice president of T. Rowe Price Group, Inc. and its affiliates and a portfolio manager in its Fixed Income Division, specializing in stable value portfolios and their underlying fixed-income strategies. Like several of his colleagues, Luna observed that the continuing low interest-rate environment will be a challenge for the stable value industry, especially insurance companies. “The longer rates stay low,” he said, “the more pressure there could be on insurance companies, especially those that have large exposure to variable-annuity products.” He said low rates ultimately could pressure credit ratings of the insurance sector.

Regarding stable value portfolio durations, Luna said he finds it punitive to be shortening duration in the current investment climate, given how steep the yield curve is. He observed that stable value managers are in some cases being forced into making minimum allocations to asset classes they may prefer to underweight or not own at the moment, including U.S. Treasuries and agency bonds. These types of securities offer lower yields and could be the most negatively impacted by rising interest rates.

Luna presented statistics indicating that despite the challenges it’s faced since the 2008 financial crisis, the stable value industry continues to grow as investors seem to be looking for attractive yields and lower volatility. Since 2008, he said, there appears to be an allocation shift as fixed income funds have seen strong demand and taken in about $1 trillion in new cash flow. During that same time, equity funds, U.S. and international combined have taken in only $150 billion.

Plan sponsors continue to make stable value investment options widely available, Luna concluded. At the end of 2007, for example, 58 percent of the plans serviced by Vanguard Group offered stable value funds, and that figure remained 58 percent at the end of 2011. At T. Rowe Price, the percentage of plans offering stable value actually grew during that period, rising to 68 percent from 63 percent.

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