Stable Value Doesn’t Mean Maximizing Returns Isn’t the Goal
Diversification of issuers and underlying securities is the calling card of this stable value fund
Defined contribution (DC) plan sponsors and advisors know all too well the challenges of enrolling workers in a plan and saving at sufficient levels to ensure a secure retirement.
Ideally, a DC plan should include (and make participants – particularly the skittish, and those in the late phases of their career and nearing retirement – more aware of) a stable value option, which are investment opportunities designed to preserve capital. But are all stable value products essentially alike? To answer that question and more, II spoke with Karen Chong-Wulff, Managing Vice President, Fixed Income, and Craig Lombardi, Managing Vice President, Head of DCIO, both of ICMA-RC. For more than 45 years, ICMA-RC has been a leader in the public sector plan space, but only in the past two years has it opened up its expertise to private plans.
Let’s start at the baseline. What are the benefits of a stable value product to a DC plan participant?
Karen Chong-Wulff: It provides for capital preservation. When you think of that advantage compared to fixed income and equities, for example, there’s a big difference in terms of the risk profile. You don’t have the same kind of volatility in stable value because of the contracts that you put in place that allow it to be held at contract value or book value. A participant wouldn’t expect returns to be as high as equities might provide, albeit the equities come with greater risk.
What’s one of the key differentiators between stable value and money market funds?
Chong-Wulff: Duration, which measures a bond or debt instrument’s sensitivity to interest-rate changes. For a stable value portfolio, the duration can range from two and half to three and a half years, in general. For money market funds that provide for capital preservation, it’s typically less than year.
So, is one stable value portfolio the same as the next?
Chong-Wulff: Absolutely not. The stable value products available on a plan lineup could include insurance-type products, which typically have minimum guaranteed rates. People like that on the surface because the minimum is typically above 0%. But it’s important to know that it doesn’t have the diversification that is fundamental to investment growth. You’re subject to one insurance company providing that minimum guaranteed rate. And depending on whether it’s a general or separate account, there are issues around transparency into the multiple securities backing up the contract, and transparency in terms of how the rate can be reset at times.
We believe providing diversification and transparency based on the number and types of issuers in a portfolio is the best approach to stable value.
What is your approach to diversification?
Craig Lombardi: A diversified portfolio should have different types of issuers included, ranging from guaranteed investment contracts and wrappers, to fixed income managers, for example. That speaks to the quality of the portfolio Karen and her team have built, and to the diversification of it in particular.
How would you structure a stable value portfolio to achieve capital preservation and returns?
Chong-Wulff: Beyond diversification through the number of types of issuers, as well as underlying securities, we would structure a portfolio in such a way that we have exposure to the different parts of the U-curve. In addition to that, diversification of fixed income managers is important. If it makes sense, we’re going to buy it, versus “Hey, I have to get all the assets and manage it all myself as a flow.” We don’t have that conflict and that is very freeing in terms of making sure that you pick the right product for the right portion of your portfolio. We believe this approach is best because in this role, we have the ability to mix and match managers to gain the optimal mix of managers, and we won’t hesitate to terminate managers who aren’t performing.
Why should plan sponsors carefully evaluate capital preservation options in their lineup?
Chong-Wulff: A stable value fund is a conservative option in a plan lineup, but in our approach we aim for as high a return as possible given the conservative nature of this asset class. Think of it this way: If you’re invested in private equity, you expect higher returns, but it doesn’t mean you don’t care about risk management. Plan sponsors should evaluate the longer-term prospects of these asset classes when determining their plan lineup.
With so much of inflows going into target-date funds (TDFs), can you incorporate stable value funds into them?
Lombardi: That’s a good point, and yes, we’ve added stable value to our own target-date series that we manage. We believe we are among the first providers to incorporate stable value within the target dates.
Are TDFs part of the competition for stable value funds then?
Chong-Wulff: You could say that since most plan participants default into a target-date fund. Stable value products are not necessarily offered as one of the investment options in terms of a default investment option. But stable value can always have a place in a retirement plan lineup, and there’s always going to be use for stable value in terms of applications to other investment options, such as being part of target-date fund.
Interest rates are certainly a major influence on a stable value portfolio’s performance. What’s your outlook in that regard?
Chong-Wulff: That’s why it’s even more important to make sure that you’re not in a cash equivalent instrument, because we believe a spread above the Treasury rates must be maintained. We would expect that spread to stay positive, even though Treasuries could become negative one of these days. I hope never, because it doesn’t make sense at all, but you see it in Europe and Japan. We expect the U-curve to be above zero, but it may stay low in the short term. As long as you invest in securities that bear above a 0% rate, you should get that rate. It’s all relative in terms of how you compare it to other conservative investment options.
Does the pressure on fees have an impact on uptake of stable value?
Chong-Wulff: I don’t think it’s any different for stable value than any other actively managed strategy. You can only go so far in keeping fees down because you want all your issuers to be in business as well. You might opt to not use as many outside managers and try to consolidate everything in-house, but you’d surrender the diversification of strategies that you have in the stable value portfolio – and you really don’t want to do that. During the financial crisis, there was a lot of focus on asset-backed or certain mortgage-backed securities to the detriment of diversification. When those areas blew up, some portfolios had to either be made whole by the provider or were closed. That’s why it’s important to have the right diversification, mixed not just by managers in terms of helping you to manage portfolios using different strategies, but the underlying securities as well.
This information is intended for institutional use only. Investment advisory services are made available to institutional clients through Vantagepoint Investment Advisers, LLC (VIA), an SEC registered investment adviser and wholly-owned subsidiary of ICMA-RC. For more information, please see VIA’s Form ADV, available at www.adviserinfo.sec.gov. When Funds are marketed to institutional clients by our Defined Contribution Investment Only (DCIO) team, the Funds are offered by ICMA-RC Services, LLC (RC Services), an SEC registered broker-dealer and FINRA member firm. RC Services is a wholly-owned subsidiary of ICMA-RC and is an affiliate of VIA.
This is not intended as a solicitation nor does it constitute investment advice. The asset class discussions included herein are not meant to be exhaustive. For additional information on a particular fund, please review the fund’s disclosure documents. Neither ICMA-RC nor its subsidiaries are responsible for any investment action taken as a result of this piece. Investors should carefully consider their own investment goals, risk tolerance, and liquidity needs before making an investment decision. Investing involves risk, including possible loss of the amount invested. Information provided has been obtained from sources deemed reliable, but is not guaranteed. Past performance is no guarantee of future results.