By Jane Marie Petty
Four stable value industry experts recently participated in Asset TV’s Stable Value Masterclass. The panelists were James J. King, Managing Director and Client Portfolio Manager at Prudential Retirement; Warren Howe, National Director of Stable Value at MetLife; Karl Tourville, Founding Managing Partner of Galliard Capital Management; and Karen Chong-Wulff, Managing Vice President of Fixed Income at ICMA-RC. The moderator was Asset TV’s Courtney Woodworth. Following are highlights of two of the topics covered during the 52 minute Masterclass: the impact of Money Market Reform on the Stable Value asset class and the experts’ thoughts on why they look forward to higher rates and why rising rates will benefit stable value. The panel also discussed several other issues impacting the industry including the overall health of the industry and where the growth opportunities are for stable value. To view the full informative Stable Value Masterclass, visit Asset TV.com
The Impact of Money Market Reform on Stable Value
The panelists all agreed that Money Market Reform presented significant opportunities for the stable value asset class. “What happened was a lot of the assets came out from prime money market funds into government money market funds. As a result you saw lower rates in government money market funds, so the spread between stable value and government money market funds were even greater. That presented an opportunity for stable value,” explained Karen Chong-Wulff. Karl Tourville added that Galliard saw strong new flows into its stable value strategies, particularly from plans that opted to eliminate their money market fund options. MetLife’s Warren Howe pointed out, however, that while Money Market Reform definitely served as a trigger point for the reemergence of stable value as an ideal capital preservation option, he emphasized that stable value has always been the right choice relative to money market options and history shows that there has always been a clear quantitative advantage for stable value. “Look at historical one year periods, three year periods, five year periods, ten year periods, and you’ll see that stable value significantly outperforms money market funds. So from a quantitative perspective, stable value has always been the right choice relative to money market funds. But now because of Money Market Reform, plan sponsors need to take some level of action, whether it is to choose to stay in a government money market fund or elect to move to stable value. As a fiduciary, they’re making a decision now. So it’s really the right time when you’re doing that analysis and you look at it as a 0% yield versus kind of stable value in the 1½-2+ range, really the time is right and stable value is positioned quite well,” noted Howe. Prudential’s Jim King also agrees that the spread between stable value and money markets is very attractive. “It’s right above the long term average. And what’s really good about the opportunity right now is that if the Fed does start to tighten, even if it’s very gradual over time, we’ll see interest rates rise not only in the short end, but in the short to intermediate part of the yield curve where stable value does most of the investing, that’s where we put our money. And so those higher rates should produce even more attractive returns for plan participants going forward.” Howe and King anticipate changes and movement from money market funds into stable value to continue well beyond the October 14th Money Market Reform implementation deadline into 2017 and 2018. Howe noted that there are still a number of plans that need more time to conduct due diligence as a fiduciary before making changes to their plans. Therefore even if plans moved to government funds, there is still a significant amount that will move to stable value beyond the October 14th date.
Rising Rates Will Benefit Stable Value
All the panelists welcome higher rates and believe this will benefit stable value. Karen Chong-Wulff explained that stable value is designed to perform well, whether rates go up or down. “What happens with stable value, because of its design, is it will rise with interest rates, not as fast as money market funds, but it is going to go up. I think we should all be excited that it’s going to go up because I wouldn’t want to be in a prolonged low interest rate environment situation where stable value doesn’t even beat inflation. Higher rates would actually be a welcome change. And because of the way the product is designed and what we’ve gone through all these years, I think we are in a really good position, you know, where we have excess reserves, in terms of the market to book value ratio. We have enough reserves for us to be able to cope with higher interest rates as well.” Karl Tourville agreed with Chong-Wulff. “ We would love to see an increase in interest rates. I think we have more risk on the downside of a low interest rate environment than we do in increasing rates. And as Karen said, stable value funds will increase or decrease with the market, but at a slightly slower rate.” Warren Howe further elaborated that “if interest rates start to rise, money market rates will rise as well. But there’s a significant cushion between the returns of a stable value fund and money market. So if you get an orderly increase in rates, you know, 25 here, 25 there, rates start to move, stable value has got a large cushion already. So it will continue to move up as well. The other thing about money market funds is many of the money market funds waived their fees during kind of the financial crisis, and while yields have been zero. So if rates pop 25 basis points, 50 basis points, that isn’t all going to come through on a money market fund because they’re going to start to reinstate their fees. So they will not get that exact pick up. And lastly, when I think about stable value, while rates rise and it has this inverse reaction to the bond market, it’s part of a Defined Contribution plan. There are regular flows of contributions from participants. And as those flows come in, they get reinvested as rates are moving up. So there’s always been a concern about stable value in a rising rate, but I think it’s a bit muted by all of that.” King agreed with the rest of the panelists. “Rising rates clearly will benefit stable value. To Karen’s point, which I think is interesting, right now the average stable fund has a yield somewhere around 1½-2%, which is running right at about the rate of inflation. So I think the Fed could move rates up one or two times you would see the short to intermediate part of the yield curve respond very favorably. And if we got rates up another say 50-100 basis points, it would begin to provide a better premium above inflation.
King also commented on asset classes more broadly than stable value and noted that while a 2% stable value rate may not sound like a lot, most models today on the stock side expect 4-6%, significantly below where they have been historically. And King noted that as rates start to rise, bond prices are going to go down. So stable value, given an increase in yield in a rising rate environment and no principal preservation downside, is going to be very attractive.
The full Masterclass discusses many other timely issues impacting the stable value industry including structural changes in stable value funds since 2008, including more stringent investment guidelines, and improved risk management practices throughout the industry. The experts also discuss future growth opportunities for the stable value asset class including increased usage in custom target date strategies and 529 savings plans. Visit Asset TV Stable Value Masterclass to stay up-to-date on industry trends.