PSNC 2016: Understanding Stable Value

The use of stable value funds within defined contribution plans has evolved substantially in recent years and decades, with more changes right around the corner. 

The use of stable value funds in today’s defined contribution (DC) plans tends to break down along three main lines, according to panelists at the 2016 PLANSPONSOR National Conference in Washington, D.C.

“The first big use is by older investors who need to protect the wealth they have while gaining some modest capital appreciation,” explained Andy Apostol, head of stable value client service at Invesco. “Next, we are also seeing more use of stable value within custom target-date funds (TDFs), and finally, related to this, we are seeing stable value serve as a capital preservation tool sitting as the anchor of a diversified portfolio.”

James King, managing director and client portfolio manager for Prudential, agreed with that assessment, explaining that from purely a return perspective, stable value has quite similar characteristics to intermediate duration, high-quality bonds.

“That gives you an idea of how they will perform in a portfolio, but it’s obviously not the entire picture,” King said. “Stable value is lower risk, and it’s designed to reduce the probability of loss as much as possible. In the simplest terms, stable value funds are basically bond portfolios, paired with insurance wrap contracts that seek to deliver a guaranteed return even when bond markets turn negative.”

There are obviously extra fees that come along with building the insurance wrappers, the panelists explained, but that’s pretty much the point: Stable value is a good option for those who are willing to pay a little more compared with bond funds in order to smooth out the return cycle.

“The best example we can give of this comes from 2008 and 2009,” Apostol suggested. “While so many funds lost a whole lot during the period, stable value delivered a steady, daily positive return. The asset class outperformed money market funds as well, and they can be expected to do so over the long term.” 

NEXT: Significant variability within stable value 

The panelists went on to outline the main types of stable value being offered on the market today, although there is even significant variability within the general archetypes, described as follows:

  • Insurance company general account products – These tend to have longer durations in the underlying bond investments, and therefore they can offer higher crediting rates in general. The wrap contracts in this case are usually single-provider contracts, however, so there is credit risk to consider regarding the insurance company. Be mindful of the crediting rate reset rules, panelists urged. There will also likely be less transparency and less portability compared with other approaches.
  • Insurance company separate account products – These have some similarities with general account products, but the insurance company agrees to hold the underlying fund assets in a separate account disassociated with the insurance guarantee, potentially reducing credit risk. Panelists suggested this approach can provide an additional level of security, a wider variety of investment strategies, and an enhanced level of portability—usually for a higher cost, of course.
  • True separately managed accounts – This approach utilizes multiple investment wrap contracts and multiple insurance guarantors, panelists explained. Securities are also held by a third-party custodian, further segmenting the insurance guarantees from the asset management portion of the product.  
  • Pooled funds designed for small investors – This approach is increasingly being utilized by plans with, say, $50 million or less, to access stable value investments. There is significant variability in how these pooled funds are invested and guaranteed, but the idea is to bring institutional pricing to smaller plans by having them all bargain together. A plan sponsor can actually use the three previously described stable value styles under this pooled approach, panelists suggested.  One key things to consider, they warned, is that the book value crediting rate of the pooled fund can be impacted by each co-investors’ decisionmkaing, especially when there is only a small number of investors in the pooled fund.