Sleepy. Quiet. Those are a couple of words that have been used to describe the capital preservation arena over the years. But with money market reform, we have seen capital preservation become one of the more significant investment policy topics during defined contribution (DC) client review meetings this year.
Most DC plans presently offer a stable NAV product such as a stable value fund or money market fund. According to Aon Hewitt’s 2015 Trends & Experience in Defined Contribution Plans report, 74% of DC plans offer a stable value fund while 40% offer a money market fund (some plans offer both). For plans that offer a money market fund, money market reform has brought this fund category to the forefront of discussions. In a nutshell, DC plans that wish to continue to offer a money market fund are being faced with two general options – offer a retail money market fund that potentially may have gates and/or liquidity fees imposed or a Treasury/government money market fund. For plans that wish to offer a retail money market fund, a practical limitation is that most recordkeeping platforms have made the decision not to support such funds due to the potential complications around gates and liquidity fees. And offering a Treasury/government money market fund is not deemed as overly attractive by many plan sponsors given depressed yields and low expected returns.
As a result, we are seeing a tremendous amount of stable value interest and search activity. Some plans have moved or are in the process of moving to stable value funds. It should also be noted that while some plan sponsors have elected to move from current money market offerings to Treasury/ government money market funds in advance of the October 2016 reform implementation, an opportunity will continue to exist for stable value managers to discuss stable value with these plan sponsors even beyond that date. With the potential for meaningful additional return of stable value funds over Treasury/government money market funds, we believe that there could be a tail of stable value opportunities that extends beyond October 2016.
From a longer-term perspective, we believe that it is critical for the stable value industry to understand the evolving focus of DC plan sponsors and determine how stable value can be an important part of the solution.
Now the question is solution to what?
In years past, DC plans were viewed as just one of the parts (and in many cases, a minor part) of the retirement equation. But with the closing and freezing of many DB plans and questions about the future of Social Security, DC plans have become more and more vital for participants. As a result, the efforts of many DC plan sponsors have changed from simply driving increased employee participation rates to determining how to improve retirement income adequacy. The stable value industry’s task is to determine how stable value can be part of the retirement income adequacy solution.
First, is it important to DC plan sponsors that there is a stable NAV product in the plan lineup? Our experience has shown that plan sponsors view a stable NAV product as an essential piece of the plan lineup puzzle. As we have both encouraged and seen streamlining of DC plan lineups, we have witnessed the capital preservation option as becoming relatively more important in serving as a truly differentiated option. Then the natural question becomes, “What is the right capital preservation option?” As mentioned earlier, stable value has been the favored choice of plan sponsors given its similar expected volatility and higher expected return in comparison to that of money market funds, and we expect that this preponderance of stable value will only grow given the effects of money market reform.
As plan sponsors focus more on helping drive stronger retirement income adequacy, our research indicates that there are three primary levers:
- Increasing savings (contributions flowing into the plan)
- Improving investment efficiency through diversification/controlling costs
- Delivering more return through simplification and broadening of the investment mandates.
On the point of controlling costs, scale of plan assets is an important factor, and more plan sponsors are seeking to encourage participants (and corresponding assets) to remain in the plan even after the participants retire. One favorable attribute for stable value is it is a fund type that is only offered in a qualified plan context, and stable value is generally of high potential utility for those nearing and in retirement. It is important for the stable value industry to remind the broader DC community of such key attributes of stable value.
In recent months, we have witnessed quite a bit of activity with stable value and there is a significant opportunity for stable value to gain market share in the capital preservation space given the changes to money market funds. In terms of the longterm value proposition of stable value, it is critical that stable value find its role in helping DC plan sponsors achieve broader plan goals such as improving retirement income adequacy.