By Randy Myers
While stable value funds emerged from the recent credit crisis relatively unscathed—none lost money and returns held well above those on money market funds—the crisis did have some fallout. Specifically, the market value of many stable value portfolios temporarily fell below book value during the crisis, prompting many wrap issuers to push for tighter, more conservative investment guidelines. (It should be noted, however, that stable value funds routinely have market-to-book ratios below 100% due to normal fixed income market movements.) This has led to pushback from most stable value wrap contract issuers to tighten investment guidelines. Which has, in turn, led to tension from some stable value managers who worry that tighter guidelines could compromise their ability to leverage their investment expertise, distinguish themselves from their competitors, and reduce expected returns for plan participants.
In an effort to help retirement plan sponsors and their consultants make better sense of the changes taking place, JPMorgan Asset Management has been working with Barclays Capital Research to develop a customized index suitable for benchmarking stable value portfolios. They are calling it the “Stable Income Market Index.”
“We think it [the index] is important to help reduce the uncertainty that exists now among plan sponsors and the consulting community,” Victoria Paradis, a managing director at JPMorgan, told participants in the SVIA’s 2010 Spring Seminar. “These people are being told their funds are looking at new duration, sector and quality constraints, and it is difficult to get their arms around what that means. We’re hoping to remove some of the industry backlog with respect to wrap negotiations to see if we can come up with some common ground.”
At present there is no single and widely accepted market value benchmark for stable value funds, Paradis noted. Unlike the typical stable value portfolio, she said, common single fixed income benchmarks may have long unsuitable durations or unrealistic sector concentrations. And custom benchmarks, reflecting a particular manager’s unique investment style, don’t allow for easy comparison between differently constructed portfolios.
In developing the new index, Paradis said, JPMorgan and Barclays did not start by looking at the existing indices or sectors that stable value managers tend to favor, but rather at the return and risk objectives they pursue: outperforming cash, and minimizing portfolio risk as measured by the market-to-book-value ratio.
What they came up with, she said, is a solution that blends three existing Barclays Capital indices in the following proportions: a 65 percent allocation to Barclay’s 1-to-5-year Government/Credit index, a 30 percent allocation to its Agency Fixed-Rate Mortgage-Backed Securities index, and a 5 percent allocation to its Asset-Backed Securities index. Importantly, the new index does not include any allocation to home equity asset-backed securities.
“The index is designed to illustrate portfolio characteristics that are of most interest to those underwriting the risks of these funds,” Paradis said. “It has a better, much lower risk profile than other broad market indices like an intermediate aggregate or aggregate index. It also reflects a realistic investment opportunity set that is efficient from an interest rate positioning perspective, and it is broadly diversified.”
Paradis said back-testing of the new index has shown that its returns consistently meet stable value objectives, which she said “is really useful when talking to plan sponsors these days.”