The stable value industry is in great shape, according to industry veteran Aruna Hobbs. It’s healthy and vibrant, with plenty of capacity. Cash flow is stable, and the asset class continues to deliver on its promise of principal preservation and steady returns for retirement plan participants.
While the trajectory of the industry is positive, like all asset classes, stable value is responding to developments in the marketplace. Plaintiffs’ lawyers have filed a succession of lawsuits alleging that stable value providers and plan sponsors have breached their fiduciary duties. Low interest rates continue to pressure stable value returns. And impending new rules for money market funds are prompting some retirement plans to rethink their commitment to those funds, with some indicating they might replace them with stable value funds.
To find out how the industry is responding to these developments, Hobbs, senior managing director and head of institutional investments for MassMutual, led a roundtable discussion with several of her peers at the 2016 SVIA Spring Seminar. She invited the audience to participate via instant polling. Joining her on the panel were Tom Felago, business development manager in Wellington Management’s U.S. Financial Intermediaries Group; Jennifer Gilmore, head of stable value portfolio management for Invesco Fixed Income; and Tom Schuster, vice president, corporate benefit funding for Metropolitan Life Insurance Co., and head of MetLife’s Stable Value Investment Products Division.
Hobbs launched the discussion by asking her audience what the capital preservation option should be in a defined contribution retirement plan—a stable value fund or a money market fund. Not surprisingly, more than three-quarters of the respondents answered stable value. But 21 percent said stable value and money market funds could coexist peacefully. None thought money market funds should be the sole option.
Next, Hobbs asked which of four major issues is likely to impact defined contribution plans the most in the years ahead: increased litigation, fee pressures, the movement away from active investment management to indexing, or regulatory change. Fifty-two percent of the audience cited litigation, followed by 23 percent who cited regulatory change. Schuster agreed with those who chose litigation, noting that the entities named in recent lawsuits represent a broad group, including plan sponsors, insurance companies and service firms. In short, he said, it’s everyone tied to the retirement plan industry. He also worried that news articles reporting the lawsuits will attract more attention than any later articles reporting their dismissal. That could have a negative impact on plan sponsors’ view of stable value.
Felago said that while he personally considers fee pressure a more important trend, he understands the concerns about litigation. Because of the stable value market’s size, he said, and the long-standing use of stable value in retirement plans, litigation is likely to remain an issue for some time.
Still, Felago said, stable value faces both challenges and opportunities. The worst outcome on the litigation front, he said, would be that plan sponsors conclude there’s just too much risk associated with stable value and that it’s not worth their time. On the other hand, he said stable value is uniquely positioned to resist the trend toward indexing. “It’s impossible to just passively replicate stable value, and the value it provides participants,” he said. “That’s really, really powerful.” Ultimately, he said, plan sponsors might conclude that if there is any asset class where it’s worth paying for active management, stable value is it.
Felago also sees an opportunity to promote stable value by further educating plan sponsors and their advisors about how much better stable value funds have performed, historically, than money market funds or inflation. Earlier, Schuster had shared results of a MetLife study indicating that many plan sponsors weren’t aware of how much better stable value has done. “We need to make sure people are clear on the difference, and what we’re providing for participants,” Felago said. “I think that, ultimately, is what will protect us.”
On the fee front, Gilmore and Felago agreed that it will be important for the stable value industry to provide additional clarity and transparency about costs. Plan sponsors, Gilmore said, want to know not just how much they’re being charged, but why. “Help me understand what goes into your pricing,” she said. “The fee has to make sense.”
Seeking to drill down further on what her peers consider the most important issues confronting the stable value industry, Hobbs asked her audience what keeps them up at night. Options included the possibility of interest rates rising and spreads widening, of rates remaining low or falling, and “other things.” “Other things” polled highest, followed by “I sleep well,” then “low or falling rates.
Gilmore said she worries most about making sure that stable value remains a relevant asset class, particularly as target-date funds continue to attract increasing volumes of defined contribution plan assets. To help keep stable value relevant, she said, it will be important that stable value funds be incorporated into future products introduced by the financial services industry.
Schuster was sympathetic to Gilmore’s concerns, warning that if the industry isn’t able to replace money market funds and short-duration bond funds with stable value funds in target-date funds, the asset class will be in a different and less favorable position 20 years from now. He said he spends a good bit of time trying to figure out how stable value could be incorporated into a “non-40 Act, mass-marketed, target-date fund.”
Felago identified low rates as an important concern, calling them “crushing” for retirees and anyone else who needs income. But he also said that in an environment where every 10 or 20 basis points of return matters, the yield advantage that stable value offers over money market funds is a marketing opportunity.
Like the audience, the panelists generally agreed that the stable value industry has not forgotten the lessons of the financial crisis, although Gilmore said she was glad to see stable value investment guidelines easing a bit, so that investment managers have greater flexibility to do their jobs. Hobbs concurred, but cautioned that “we want to be careful we don’t go down the slippery slope where, in five or 10 years, we’re wide open again, with the same errors made before the crisis perhaps made again.” Schuster said the crisis taught the industry that investment guidelines should not be based purely on quantitative factors, but also should take into account an investment manager’s experience and expertise.
About two-thirds of the audience agreed that the most common response by plan sponsors to looming money market reforms will be to switch from prime money market funds to government money market funds, which won’t be subject to new liquidity gates and redemption fees. Another 24 percent expect plan sponsors to switch from money market funds to stable value funds, and about 7 percent expect sponsors to switch to laddered portfolios of ultra-short fixed-income securities.
Only 11 percent of the audience said they could imagine stable value management becoming more passive, or indexed, but a hefty 38 percent said it might happen. Still, that left 51 percent who said it won’t.
Hobbs asked the audience where they see the biggest opportunities for the stable value industry—in the wider incorporation of stable value funds into target-date funds, in the higher use of managed accounts, or in making stable value a part of new retirement income solutions. Nearly 39 percent cited the target-date option and 16 percent voted for retirement income solutions, while 45 percent said “all of the above.”
Schuster noted that the stable value industry might benefit indirectly from new Department of Labor rules requiring investment advisors to always act in the best interest of their clients. Right now, he said, about $400 billion is rolled out of workplace retirement plans into IRAs each year. Some experts argue that workplace plans, featuring low-cost investment options vetted by an investment committee, are a better deal than IRAs. If the new DOL rules simply cut by half the volume of IRA rollovers, Schuster noted, it would result in an additional $200 billion staying in workplace retirement plans each year. Workplace plans, of course, are generally the only place where stable value is an investment option. “Through no effort of our own, that might be a substantial growth opportunity, and probably near-term one that exceeds many other opportunities,” Schuster said.
Hobbs said opportunities for stable value related to retirement income solutions may depend upon what fiduciary protections are granted to those products. “If that comes out positive, we might see greater interest in these solutions,” she said, adding that “there may be a spot for stable value in them as a way to provide principal protection.”
Hobbs concluded the roundtable discussion by asking audience members whether they felt there was enough capacity in the stable value market to withstand another market disruption. Nearly 36 percent said “yes,” 13 percent said “no,” and 51 percent said it depended on the nature of the disruption.
“I would have thought most people would say ‘yes,’” Hobbs observed. “In the last SVIA survey, when contract issuers were asked how much additional capacity they could provide, the answer was around $80 billion. That’s a substantial number.”
Hobbs added that beyond looking at data like that, she could gauge the health of the stable value industry by the number of events taking place at the SVIA seminar and the amount of networking and other activity taking place there. On that score, she concluded, the industry appeared healthy indeed.