PANC 2014: Fixed Income and Stable Value

Since the financial crisis of 2008, investment managers and retirement plan advisers have learned to be far more cautious when creating and selecting a stable value fund.

That was the consensus of speakers on the “Fixed Income and Stable Value” panel at the 2014 PLANADVISER National Conference on Tuesday. “The market sell-off put many stable-value funds under pressure, pushing them below par to the low 90s,” said David Solomon, vice president and head of retirement services at Goldman Sachs Asset Management. On the other hand, “most of the stronger products attracted money despite the significant declines in other funds, pushing these funds to 101, 102 above par.”

Immediately following the crisis, a lot of banks and insurance companies that offered wrappers got out of that business due to the heightened sense of risk,” Solomon said. For those that remained, “guidelines got a lot stricter and durations tightened, making the products more challenging to differentiate or drive alpha. Wrap fees increased substantially.” The good news, however, is that in the past 12 to 24 months, “new wrappers have come in, there is more capacity and more liquidity in the market,” Solomon said.

As the financial crisis erupted and “banks were tipping, clients asked us—urgently—to review wrappers,” said Robert Kieckhefer, managing partner of The Kieckhefer Group. Before 2008, the stable value funds Kieckhefer used typically had between one and three wrappers. Now, the firm looks for funds with five to eight wrappers. That is one of the key lessons learned, along with carefully “looking at the funds’ holdings to see what they are invested in. You might not like all that you find.”

For a full 22 years before 2008, Spectrum Investment Advisers used a stable value fund from a single “annuity provider. That worked well with declining interest rates,” said James Marshall, Spectrum president. Now, Spectrum uses stable value funds “with multiple insurance wrappers from a dozen different fixed-income providers.”

As to how large of an allocation an adviser should recommend that an investor assign to stable value, Spectrum manages $1.3 billion in assets, with 13% allocated to stable value. The firm also offers seven model portfolios, six of which have a small portion invested in stable value, Marshall said. Given that the current bull market is entering its seventh year, Spectrum is advising its clients to “move their position up a little bit to 15%,” he said.

Goldman Sachs recommends that its defined contribution (DC) plan investors allocate anywhere between 10% and 20% of their assets in stable value funds, Solomon said, while reminding them and their plan sponsors that “the biggest risk is demand for liquidity at an opportune time.”

Then there is duration risk, Kieckhefer said. As a result, the stable value funds that Kieckhefer recommends to clients “have maturities equivalent to a medium-term bond fund, to sustain a yield. These are not liquid investments.”

As to what duration of a put provision Goldman recommends to clients, Solomon said: “We believe in a 12-month put provision. If you want additional yield, a 24-month put might be more appropriate. You need to strike the right balance between liquidity and yield.

Kieckhefer typically recommends stable value funds to clients for safety, rather than yield. “We aren’t crazy about chasing yield in stable value. We look to fixed income for yield,” he said. That is why he is comfortable with a 2.5-year put on a stable value fund.

For retirement plans with highly paid participants that have job security, Kieckhefer might even recommend a stable value fund with a five- to six-year put. “Many stable value funds are tailored to their audience, like higher education, which tends to have a stable work force. They can go after longer durations. Others have huge cycles in their business,” he said.

To evaluate a stable fund manager, Marshall said, “there isn’t a [provider like] Morningstar to make it quick and easy.” He recommends that advisers “first, do a spreadsheet to look at duration. Next, look at the number of wrappers. Question whether the company has an adequate support team to do due diligence. Fourth, we recommend puts of 12 months or less.”

Should the economic environment begin to change to indicate a pending rise in interest rates, Kieckhefer says he recommends his clients move out of a long-duration fund into “alternatives, floating-rate funds and ultra-short bond funds.”

Marshall expects that because of the tremendous pressure the Federal Reserve is under to strike the right balance on interest rates, rates will not spike but rise slowly, which he believes will benefit stable value funds.

Kieckhefer, on the other hand, thinks that a sharp rise in interest rates is a “spring-loaded trap,” adding that now that “the economy is getting some traction, we are playing defense.”