Stable Value Industry Urged to Articulate Risk Management Processes

By Randy Myers

Stable value investment managers and wrap issuers devote huge chunks of their time to managing risk. Now it’s time to start documenting those efforts, says Susan Mangiero, managing director of Fiduciary Leadership LLC, an independent research and training company serving institutional investors.

Regulatory and legal developments have much to do with the new imperative, Mangiero told participants at the 2010 SVIA Fall Forum. On the regulatory front, the U.S. Department of Labor recently announced that it wants to expand the definition of a fiduciary for the retirement plan market. Also, the new Dodd-Frank Wall Street Reform and Consumer Protection Act charges the Securities & Exchange Commission with creating a uniform standard of fiduciary best practices that will apply to financial services firms.

In the courts, meanwhile, some retirement plan sponsors have been sued recently by plan participants attributing investment losses to breaches of fiduciary duty by those sponsors. Mangiero warned that it would not be surprising if participants began levying such claims against retirement plan investment committees, their advisors. and their asset managers, too.

More broadly, of course, there have been disastrous examples of failed risk management over the past decade that have heightened public and government focus on risk management. They range from missed accounting irregularities at some of the nation’s biggest corporations to the near implosion of the global banking sector after financial services firms took too much risk with mortgage-backed securities.

In short, Mangiero said, investment losses are getting harder and harder to explain, and anyone hit with a lawsuit should be able to clearly enunciate the risk management principles behind their product. “You want to be able to point chapter and verse to the processes in place–hopefully good processes,” she said. “You don’t want written evidence that you’ve got bad policies and procedures.”

Major issues

Issues of particular concern for the stable value industry, Mangiero said, include asset allocation, portfolio transparency, and derivatives.

Asset allocation issues are at the center of a growing number of lawsuits, she said, and that makes it important for retirement plan investment committees to be able to justify their choice of stable value funds. They need to understand the underlying investments as well as the stable value investment contracts.

Transparency is becoming a more important issue because regulators are demanding increased disclosure about investments held by retirement plans, including the valuation of those investments. That, Mangiero said, could open additional avenues to lawsuits.

“Suffice to say that anything that is going to hit the financial statements as a footnote or on financial statements proper is going to get more and more attention from the CFO, the board, and shareholders,” Mangiero said. That will put more pressure on stable value investment managers, wrap providers, and plan sponsors to make sure risks are properly identified, measured and managed.

A holistic approach

Mangiero stressed that it is important for the stable value industry to look beyond quantitative risk measures when developing their risk management policies. “It has been proven over and over again that a lot of the risk issues that have caused problems in the past were not and could not have been picked up by numbers,” she said. “It requires adopting a holistic or comprehensive risk management process that looks at operations risk, business risk, and legal risks–the panoply of risks that are not going to show up in a numerical risk management report.”

Once companies have implemented a strong risk management program, Mangiero said, they should let the world know about it. “It’s something that can help you, from a business development point of view, retain clients,” she said.

To broadcast their competence in this area, Mangiero said, companies could host or participate in education seminars on the subject, and develop a scorecard that compares their policies and procedures to industry best practices. “My strong view is that more and more, doing good things in risk management and publicizing it is going to allow you to differentiate yourself from your competitors,” she said.

While plan sponsors initially may wonder why a stable value provider is detailing risks for what has long been marketed as a low-risk product, Mangiero argued that in the long run, they will appreciate it.

“I’ve heard some organizations say we’re not going to explain this or that because it’s proprietary,” she added. “That’s fine, but understand that every action has a reaction. If I’m on a plan investment committee and somebody tells me something is proprietary and they’re not going to explain it, I’m going to be scratching my head and thinking seriously about whether we’re going to go forward. That may have worked in the past, it’s not going to work for the future. There’s too much at stake.”