By Randy Myers
As the stable value industry has moved to tighten wrap contract terms for stable value funds over the past two years, it has gotten some pushback from an important constituency–employers who make the ultimate decision on whether to include stable value funds in their 401(k) plan investment lineups.
“We’re getting some resistance from plan sponsors,” Tony Camp, vice president of the Stable Value Product Group for wrap issuer ING, told participants at the SVIA’s 2010 Spring Seminar. “Some have actually surrendered their stable value option in favor of a money market fund, and that’s something that, several years ago, nobody thought any plan sponsor would do.”
The contract changes being pushed by wrap issuers have been designed to assure the long-term sustainability of stable value funds by lessening the chances that issuers will have to step in and make good on the book value withdrawal guarantee their contracts offer to plan participants. For example, wrap issuers have sought to classify a broader array of investments as “competing funds” that can’t take exchanges directly from stable value funds, and to expand the definition of employer-initiated events that can minimize a wrap provider’s obligations. That has led some plan sponsors to complain that they and their plan participants don’t have as much control over their assets as they would like.
“Maybe we’re being too conservative,” Camp suggested.
To get a better handle on how different factions of the stable value community view contract issues, the SVIA recently polled a group of 21 stable value managers, 18 wrap issuers, and eight plan sponsors. Among the highlights, the survey found that while only about half of all managers and wrap issuers thought their industry should adopt standardized wrap contract terms, 75 percent of plan sponsors favored that idea.
Not surprisingly, the survey also found that issuers take a broader view of what constitutes a competing fund; 89 percent counted self-directed brokerage options as competing funds, for example, versus only 38 percent of plan sponsors. One area where that trend didn’t hold true: only 33 percent of issuers said they consider TIPS funds—funds that invest in Treasury Inflation-Protected Securities—to be competing funds, while 50 percent of plan sponsors said they view them that way.
A clear majority of all respondents—70 percent—said they would support the development of standardized equity wash rules for the stable value industry. Equity wash rules require that transfers out of a stable value fund must go into an equity fund for a predetermined period of time, usually 90 days, before being moved into a competing fixed income fund. This protects the remaining value of the fund for the participant and
discourages arbitrage by retirement plan participants between stable value and competing funds.
In addition, 49 percent of respondents said they had temporarily lowered their crediting rate formula in the recent past in a bid to bring the book value and market value of their stable value portfolios into closer alignment. By contrast, only 4 percent said they had changed their crediting rate permanently.
Even more respondents—70 percent—said they had changed their investment guidelines for new pieces of business they’d undertaken, and 74 percent said they had done so for existing mandates.
Two-thirds of wrap issuers indicated that they have stopped providing wrap contracts for several types of investment strategies. Most significantly, six of 18 said they had stopped wrapping core fixed income strategies and 12 said they had stopped wrapping core-plus strategies.
Approximately half of all stable value managers and wrap issuers said they had changed their investment guidelines in a broad range of areas, including duration cap, overall credit quality minimums, single-security exposure, sector exposure limits, and sector credit minimums. They also said they had made a significant reduction in the use of non-benchmark sectors such as high-yield bonds and emerging market debt.
Stable value issuers, who have been pushing for more restrictive investment guidelines, were most enthusiastic about all these changes; 83 percent said the changes would be beneficial to the stable value industry in the long-term. Three-quarters of plan sponsors agreed with that view, but only 52 percent of stable value managers agreed.
Some stable value managers think the implications of tighter investment guidelines are dire. One third said they think the changes will not allow stable value funds to deliver a meaningful return premium over money market funds in the future. “That’s a little surprising, and troubling,” Camp said. Wrap issuers and plan sponsors were more sanguine; 94 percent and 75 percent, respectively, said they think that premium will be maintained.