Stable value funds, while perhaps not on the sexiest end of the retirement plan investments spectrum, “require careful attention not only during the initial selection phase, but on an ongoing basis as well,” note the authors of the latest comprehensive trend report from the Blue Prairie Group’s Investment Analytics Group.
Blue Prairie is a Chicago-based institutional retirement and consulting fee-only firm with an affinity for stable value funds -- and expertise in analyzing them.
“At Blue Prairie Group, we believe that stable value is one of the most important asset classes in a participant-directed defined contribution retirement plan because of its ability to deliver a ‘safe’ return to participants with significantly lower volatility compared to a stock or bond fund,” state the report’s authors.
The group’s analysis is based on information gathered both from insurance company GICs and multiple-wrapper pooled products. Blue Prairie’s latest report also offers some useful due diligence pointers for stable fund evaluation.
Although their slice of the typical asset allocation pie chart for most plans has gotten thinner, stable value funds remain a core alternative for most plans, representing about one-fourth of all DC plan assets, according to the Stable Value Industry Investment Association.
We recently reported on findings from a MetLife survey which found, among other results, that more than 78% of plan sponsors are planning to maintain their offerings of stable value funds.
Following are some highlights of the Blue Prairie report, based in the period thru the 4th quarter of 2012.
Underlying portfolio performance varies widely: It ranged from 1.28% to 3.1%. Annualized over a three-year period, the range was between 1.31% and 4.3%. “This disparity is due to disparities between insurance company and pooled investment product,” the report states.
Market-to-book ratios generally decreased. This trend is “due to a continuing depressed interest rate environment and a rallying equity market, which drove down the demand, and thus prices, of bonds,” according to Blue Prairie’s analysts.
Insurer products performed best. Insurance company-issued stable value funds, standard GICs and Separate Account GICs “had the highest returns as a result of having higher levels of underlying portfolio credit risk, duration, or a combination of both.”
Higher average durations: The funds offered by insurance companies “had average durations of approximately 4.12 years, which is significantly higher than the pooled funds, which had an approximate duration of 2.43 years.” Over al longer period of time, however, all stable value managers “have clearly been positioning their portfolios for the inevitable rise in interests by shortening durations.”
Crediting rates are gradually falling over the long term: This is due to new contributions being invested in lower-yielding bonds, and wrap fees eating into yields, particularly given higher proportional investments in money market funds as managers anticipate falling bond prices. “We expect crediting rates to continue to fall,” the analysts predict.
Fund fees vary widely: Blue Prairie’s analysts found the range from 15 to 75 basis points, with the lowest fees offered by pooled funds available to larger plans. Not surprisingly, fees available to smaller plans are higher.
What to look for
In assisting their clients to judge the stable value funds currently being used, advisers can seek answers to following partial list of “kick-the-tires” questions that Blue Prairie has compiled (distilled from the full report):
1. What is the fund’s current market-to-book value ratio? For contest, during the 4th quarter of 2012, most pooled stable value funds had a market-to-book ratio higher than 103 percent, according to the survey.
2. What is the fund’s current crediting rate and how does it compare to the rates paid by other stable value funds? “Generally speaking, longer duration portfolios have higher crediting rates than shorter ones,” the analysts point out.
3. What is the nature of any significant cash flows in and out of the fund over the last three years? Major cash flows affect when, and for how much, securities in the underlying portfolio are purchased, and therefore impact crediting rates.
4. Which financial institutions are wrapping the fund, or the bonds owned by the fund? What are the most recent credit ratings and outlooks on these companies from the credit rating agencies? Knowing the financial condition of the underlying wrap providers is an essential step in evaluating the overall risk of the fund.
5. Do the book value contracts allow the wrapper to terminate the contract at market value? “Knowing this is important if the plan sponsor or investment manager experiences a change of control of over 50% of the ownership of the entity.” (Understanding all contract termination provisions is required as part of a thorough stable value fund due diligence process, Blue Prairie points out.)
6. What are the high-level risk characteristics of the underlying fixed income portfolio? “Knowing how the managers generated a fund’s past performance, and how the portfolio is invested today, can provide some insight into how the fund will perform in the future.”
7. What are the fund’s investment guidelines for the appropriate levels of interest rate risk (duration), and credit risk for the fixed income portfolio? (This speaks for itself.)
Additional questions include such important considerations as the identity of the underlying fixed income portfolio managers, communication resources available to participants and, of course, fee structures. Blue Prairie points out that many pooled funds “have multiple share classes designed to provide different levels of revenue sharing to the recordkeeper.”
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