Data & Research January 11, 2016

The Stable Value Conundrum

Why do so few DC plans offer stable value funds on the investment menu?
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For years, fewer than half of defined contribution (DC) plans have offered stable value funds. It’s not because plan sponsors and plan advisers don’t know about the asset class. And it’s not because they don’t know about stable value’s benefits: most people know the funds offer steady returns and principal protections.

Prudential Retirement set out to understand the barriers to adoption, and found in its new white paper, “Expanding the Case for Stable Value,” that growing numbers of plan sponsors and intermediaries may in fact be open to embracing stable value.

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While the research didn’t yield any top-level surprises, says Gary Ward, head of stable value at Prudential Retirement, it allowed Prudential to gain insights from key decision makers and influencers across the retirement landscape. In particular, Prudential understood more deeply the opportunities for growth of stable value in DC markets. Prudential and the investment industry need to put forth more effort on articulating the value of this asset class, Ward tells PLANADVISER, while addressing perceived costs.

“Some of the differences between those adopting and recommending stable value, and those not taking advantage of stable value were more glaring than I expected,” Ward says. 

In some ways, those who don’t recommend stable value may be looking at the wrong factors. For example, those recommending stable value cite its returns versus other fixed-income investments, while non-adopters cite stable value’s performance relative to equities and other non-fixed income asset classes, Ward points out. “Those recommending stable value cite its role in boosting participation and deferral rates of participants, and the liquidity provided to participants, while those not adopting think it may be difficult for plan participants to understand.”

For Prudential Retirement, the research opened up an evaluation on how they tell the story of stable value’s benefits to an individual investor. “I didn’t expect to hear as much of as we did about benefits, that plan sponsors and intermediaries really see the connection of stable value to broader participant engagement,” Ward says. “They see it as a driver of higher participation and deferral rates.”

NEXT: Raising awareness and analyzing real or perceived concerns

One key to educating plan sponsors and investment committees about stable value is a deeper articulation of the value equation of the asset class, according to Ward. “We need to emphasize all of the benefits of stable value, such as the history of bond-like returns with low volatility, capital preservation, liquidity to participants, and potential to drive higher participation and deferral rates,” Ward says. “And we need to continue analyzing real or perceived concerns around cost and complexity.”

Awareness alone is not the issue. Prudential’s data shows that almost all advisers (91%) and most plan sponsors (82%) are somewhat to very familiar with stable value. “This is about providing the right information for key decision makers to evaluate stable value versus other conservative options,” Ward says.

Prudential contends that several factors mean that greater use of stable value is inevitable. First, plan sponsor and intermediary attitudes toward broader use are favorable. Among plan sponsors, 55% of non-adopters plan to offer stable value in the future, while only 9% of adopters are at risk of getting rid of it. For advisers, 30% of those who recommend stable value to clients are doing so more often today than they did a year ago, and 35% expect this trend to accelerate over the next three years.

Another factor is the changing regulatory environment for money market funds. Beginning in October, the Securities and Exchange Commission (SEC) will allow money market funds to impose redemption fees, or temporarily halt redemptions, when the funds fall below certain liquidity thresholds, which could spur more interest in stable value funds as an alternative. Sixty-three percent of sponsors that currently offer money market funds and 49% of advisers who currently recommend them say the SEC ruling is likely to drive changes in their allocation to money market funds.

Prudential surveyed 400 plan sponsors and 300 intermediaries to identify the factors that motivated them to adopt stable value and recommend the asset class to others. Plan sponsors and intermediaries that had not yet embraced stable value were also asked to identify the barriers to adoption. Plan sponsors refers to companies with 401(k), 403(b) or 457 plans, with $100 million to $500 million in total plan assets. Intermediaries refers to retirement plan advisers, registered investment advisers (RIAs) and broker/dealers, many with national or regional brokerage firms or wirehouses, most with significant business with clients that have less than $100 million in total plan assets.

“Expanding the Case for Stable Value” can be accessed from Prudential’s website.

The Markets January 8, 2016

Effects Clients Will See from SEC Liquidity Risk Efforts

John Hollyer with Vanguard sees the SEC’s new efforts having a minimal effect on retirement plan investors.
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The Securities and Exchange Commission (SEC) has proposed a set of reforms about open-end funds’ liquidity management programs.

The agency explains that it is proposing a new rule 22e–4 under the Investment Company Act, which would require mutual funds to establish liquidity risk management programs. Under the proposed rule, the principal components of a liquidity risk management program would include a fund’s classification and monitoring of each portfolio asset’s level of liquidity, as well as designation of a minimum amount of portfolio liquidity, which funds would tailor to their particular circumstances after consideration of a set of market-related factors established by the SEC.

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John Hollyer, global head of Vanguard’s Investment Risk Management Group in Malvern, Pennsylvania, explains that a fund’s liquidity is not just in cash, but also securities that can easily be converted to cash, such as commercial paper or government bonds. Under the SEC’s proposed rule, funds will have to describe what securities will make up the fund’s liquidity and how much of each security the fund will hold at a minimum.

Hollyer tells PLANADVISER that Vanguard is concerned that the security classification rules are much more restrictive than what is required currently. “The SEC is asking for much more accuracy than mutual funds can know, for example, how many days it will take to settle a specific bond,” he says. Vanguard has concerns that the selectivity of securities based on liquidity will differ among funds and it will affect the ability to compare asset managers.

In addition, Hollyer says these requirements will be complex and costly for mutual funds, while not giving the SEC more insight on the level of security risk. “They need to justify what is required is worth the expense and burden,” he states. Vanguard has expressed its concerns in a comment letter to the SEC, but Hollyer notes that Vanguard supports the SEC’s efforts to have funds establish a top-down board-approved liquidity management program.

NEXT: Will retirement plan sponsors and participants see any effect?

For plan sponsors, Hollyer notes, mutual funds have a very strong track record of managing risk and liquidity. “So you could argue that plan sponsors have been well-served by regulations so far, and depending on the final form of the new regulation, sponsors could benefit from knowing firms have higher standards for risk management,” he says.

“If mutual funds were less fully invested in the market because of liquidity requirements, that could be a detriment, particularly to long-term investors,” Hollyer adds. And, there could be the potential for increased costs passed to investors by mutual funds, but all this depends on the final form of the regulations after the SEC has considered comments.

In order to provide funds with an additional tool to mitigate potential dilution and to manage fund liquidity, the SEC proposed amendments to rule 22c–1 under the Investment Company Act to permit funds—except money market funds and exchange-traded funds (ETFs)—to use ‘‘swing pricing,’’ a process of adjusting the net asset value of a fund’s shares to pass on to purchasing or redeeming shareholders more of the costs associated with their trading activity.

Hollyer explains that this means when cash flows in or out rise above a certain threshold, the mutual fund could choose to adjust the cost of the fund that day to account for the number of investors who bought or sold on that day. Long-term investors, such as retirement plan participants, would benefit from this because they would not bear the cost of frequent traders.

Hollyer notes that in response to the global financial crisis there have been a variety of initiatives to improve the management of systemic risk across the nation’s financial system. In late 2015, the SEC mapped out a program of five things it would do in overseeing management of the mutual fund industry. The reason the SEC puts importance on liquidity risk management, is that mutual funds offer daily redemption as a feature. There has been a track record of more than 75 years of successful regulation, he says, but in response to the global financial crisis the SEC is making an effort to make sure risks are fully understood.

“I think the most important thing is to remember is that the mutual fund industry has benefitted from sound regulation and there really has not been a problem with having adequate liquidity. This represents an effort to go to a higher level,” Hollyer concludes.

 

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