Plan sponsors’ misunderstandings about stable-value
funds fall at two ends of the spectrum, says Marcia Peters, chief investment
officer at Warren, New Jersey-based adviser Portfolio Evaluations Inc.
“Historically, most sponsors thought of stable value as being similar
to money market, and that they could put it in the plan lineup and it
would perform,” she says. “The other extreme is, sponsors have
started to realize that they are not a money-market fund and they have
things in them that are higher risk than a money-market fund. Some have
said, ‘These things are too complicated.’
“Our goal is to educate plan sponsors so they understand
where stable value really falls, and help them understand its benefits
and its potential risks,” Peters says. Advisers can help sponsors
comprehend stable-value funds by encouraging them to follow these five
rules:
1) Stay abreast of industry dynamics. Some stable-value
providers, such as State Street Global Advisors, have announced decisions
to exit the market. Fund managers and wrap providers worry that if interest
rates start to rise rapidly, while stable-value fund yields are low
relative to current interest rates, participants and plans may pull
their money and look to get higher returns elsewhere. Many stable-value
funds let plans withdraw with a 12-month notice; otherwise, participants
may transfer out at any time. Those allowances could be problematic,
considering many of the stable-value funds hold underlying investments
in the two- to three-year duration range, on average. If plans and participants
want to leave, stable-value funds would then have to sell underlying
investments at losses to fund the redemptions. “If that happens, the
fund is stuck,” says Charles Nelson, president of Great-West
Retirement Services. “That is why many wrap providers are saying,
‘I am only making a few basis points, and I am taking a lot of risk
for that.’” As a result, stable-value managers have found that the
wrap market tightened up quite a bit.
That means wrap providers can push the envelope on
fees. Wrap-contract fees once ran between seven and 12 basis points
and now run 18 to 25, says Sue Walton, a Chicago-based senior investment
consultant at Towers Watson. “The risks have not been completely sorted
out,” Nelson says. “Everybody is still asking, ‘When are
interest rates going to rise? How fast will they rise? And to what level
will they rise?’ Since those answers are unknown, fees may continue
to rise.”
2) Know these products’ mechanics. The biggest
misunderstanding about stable-value funds among sponsors and advisers
is not knowing how much they can differ, says Chris Tobe, principal
at Louisville, Kentucky-based Stable Value Consultants. “They think
of it as a generic, plain-vanilla investment,” he says.
Most plans have, in recent years, used synthetic stable
value—a fixed-income portfolio with an insurance wrapper around it.
“With synthetics, you have the assets in your name,” Tobe says.
“If the insurance company goes under, maybe you are out three or four
cents on the dollar, at most.”
Adapting to the capacity constraints in the wrap market,
some fund managers have added more traditional guaranteed investment
contract (GIC) and sub-advised structures to their products. “The
landscape has changed so dramatically that a lot of stable-value funds
increasingly have been forced to use these tools in the face of mounting
underwriting standards the insurance industry has placed on the managers,”
says Edward McIlveen, director of investment analytics and research
at adviser Francis Investment Counsel LLC in Pewaukee, Wisconsin. That
makes it key to track the credit-worthiness of all entities providing
capacity for these stable-value funds; so, he sends quarterly updates
to sponsors with stable-value options.
Sponsors also need to know how the wraps work. Since
a number of wrap-contract providers have exited the market, those who
remain have more leverage in how to structure the wraps. “You used
to have more ‘global’ wrap contracts, so if there were five
wrap providers, the others had to step up if one failed,” Walton
explains.
“Now, they are structured so that you have got a
wrap provider covering a portion of the portfolio.” So if a wrap provider
covering one part of the portfolio fails, a wrap provider covering another
portion is unaffected.