Its reputation recently took a hit, but money market worries and the resulting reform have stable value back on track. Who’s doing it right and, more importantly, how can it help 401(k) advisors build safe(r) portfolios for participants?
“There’s danger in safety;” it’s a clever and counterintuitive play on words, a cliché thrown about since 2008 that references the ongoing anxiety in the fixed-income space as it relates to interest rate risk. Investing 101 dictates that interest rates and bond prices move inversely, so after an equity exodus and flight to safety in the form of fixed-income, a portfolio’s value could further erode by interest rates that have nowhere to go but up.
Further confusing matters is the volatility in money market funds (you read that right). The once safe investing sanctuary ran into trouble when The Reserve Primary Fund broke the buck in September 2008. Concern continued in the aftermath of the economic crisis, culminating in SEC reform in July 2014 that includes liquidity fees and floating NAVs on certain types of money market investments.
What’s it all mean? Opportunity for like-products, specifically stable value funds. What are stable value funds and why are they specifically effective in 401(k) plans? We asked some of the top stable value providers for help.
MetLife
WHY STABLE VALUE FUNDS, AND WHY NOW?
“First and foremost, stable value funds should be considered for the excess return they generate over mutual funds over time,” says Thomas Schuster, vice president of stable value and investment products with MetLife. “It’s the only option designed specifically for the defined contribution space. Money market funds are for the retail market. Stable value funds are also designed to go further out on the yield curve for longer durations.”
We weren’t sure if our description of a stable value “resurgence” was necessarily accurate. Schuster and his colleague Warren Howe, national sales director for MetLife stable value markets, put us at ease.
“There has been a resurgence in stable value funds,” Howe says. “There has always been a case for stable value funds over money market funds, but now with the new regulations, it’s even stronger.”
Research seems to back them up. “MetLife’s 2015 Stable Value Study,” released late last year, found a vast majority (82 percent) of 401(k) plan sponsors who are familiar with the new rules governing money market funds feel stable value is a more attractive capital preservation option for plan participants.
It also finds most stable value fund providers and advisors predict that the use of money market funds in defined contribution plans will decline over the next few years. The result? More stable value use.
Howe adds that there have been two significant rounds of changes with money market funds, not only to the structure but also the return. For instance, money market fees were not always counted in the return, and now that they are counted, stable value funds are even better by comparison.
“Stable value funds tend to have longer duration times than other pooled products out there,” he argues. “Any stable value fund will outperform money market funds over time and duration.”
As to why MetLife, in particular, does so well in the space, Schuster attributes it to the investment giant’s “open-mindedness.”
“We design stable value funds to the risk return profile of the particular plan,” he concludes. “It’s about customization, rather than trying to position one product across the board. MetLife has been in the stable value business for 40 years through all market cycles. We therefore don’t overreact and have perspective that our competitors don’t.”
Columbia Threadneedle Investments
ASK LEONARD APLET about Columbia Threadneedle’s dominance in the stable value space and he immediately points to research. It’s easy to see why.
“We have 12 stable value team members, 66 fixed-income research analysts, and over 180 fixed income professionals overall,” says Aplet, senior portfolio manager, head of short duration fixed-income and stable value with the firm. “So there’s a huge emphasis on the research team. Also, we have the stability of our cash flows and our high quality portfolios.”
He notes the two “flavors” of stable value products provided by the firm—government-only and investment grade.
“It doesn’t matter if they’re co-mingled trusts or large institutional clients, either can buy in,” Aplet explains. “Government-only is appropriate for those that don’t want to be subjected to credit risk.”
Unsurprisingly, he too notes the new money market fund regulations are perfect for stable value products to act as an alternative, “which have a higher return and similar stability.”
Jim McKay, portfolio manager for stable value management at Ameriprise Trust Company [which has owned Columbia Threadneedle since 2009] adds that the diversification aspects of their wrap provider relationships is also a contributing factor to the company’s outperformance in the space.
“We have relationships with eight to 10 stable value wrap providers, so the marketplace is solid,” McKay notes.” It was a good investment back in 2008; the issue was that wrap insurance issuers saw more risk overall and pulled back or froze business altogether. However, others stepped up to fill the issuer gap. Today, there is once again more capacity and flexibility in stable value wrap contracts.”
Putnam Investments
IF YOU UNDERSTAND the 401(k) space and engage as an advisor in education and enrollment, you’ll be ranked highly no matter what product you offer to plan participants. Boston-based Putman Investments seems to have figured this out.
“As money market rates are dropping to basically zero, stable value funds have been a great source of yield,” says Scott Sipple, head of global investment strategies at Putnam. “The guarantee is a large part of that; the ability to get yield as an alternative to money markets.”
Putnam is known in the space because, as Sipple argues, “we are fortunate to have a world-class fixed-income group, can look at a broad number of credit instruments to put it into the portfolio.”
And then there’s the issue of capacity. As the market tanked for just about everything in 2008, wrap providers pulled back, but Putnam has “great wrap relationships” due to one major competitive advantage—it’s alignment with Great West Life.
“That relationship is certainly an advantage,” Sipple concludes. “They have competitive products and instruments.”
Galliard Capital Management
WE MUST SAY, the stable value educational material Galliard Capital Management sent through prior to our interview, and specifically the differences between stable value and money market funds, was first rate, and worth a look by 401(k) advisors.
Mike Norman, partner at Galliard Capital Management, concedes the concept behind the rise of stable value funds is driven by money market reform, but he also claims that word is getting out about the intermediate bond risk/return profile, one without money market funds’ daily volatility.
“Our story has been super-consistent,” Noman says. “We realize when it comes to conservative investments interest rates are rising, but stable value funds will stay positive as other areas of fixed income go negative, which is an advantage.”
He also says that user demographic for stable value funds has traditionally been older.
“Now, there is a stable value upswing with millennials because they know nothing but volatility; it’s what they’ve grown up with,” Norman adds. “It’s saving vs. investing, keeping and protecting money as opposed to making money. They recognize it has a role to play in the low-volatility portion of their portfolio.”
Nick Gage, Galliard’s head of stable value separate account management, also points to the attention the space is getting from “traditionally non-stable value users,” and that plan sponsors are looking at it for principal protection.
“Stable value adds 150 to 200 basis points per year over institutional money market funds with similar timelines,” Gage says. “As retirement saving has a long time horizon, it can make a significant difference. Our success has to do with the experience and the continuity of our team, their confidence with clients and the credibility we bring not only with stable value funds but the underlying fixed-income portfolio.”
Vanguard Stable Value Management
STABLE VALUE IS a smart, conservative strategy, so of course Vanguard will show up on a list of who’s-who in the space.
“In a low interest rate environment, stable value funds looks good,” says Susan Graef, a principal in Vanguard Stable Value Management, a group responsible for managing $26 billion in assets for defined contribution and 529 plans, including $18 billion in pooled stable value offerings. “In 2008, volatility hit all sectors and plan sponsors took a look at all investment options. Stable value funds were not alone in that.”
Fast-forward past the credit crisis, she explains, and plan sponsors are looking for another principal-protected product as an alternative to money markets. And guess what comes up big?
“Vanguard has higher yields and longer durations of underlying funds” Graef says when asked about what the firm does different. “It’s our approach to fixed income, and our controlled risk is very good.”
Stable value was able to navigate its way through the credit crisis, and it earned about as expected and at times above what was expected, she notes.
“Why did it get a bad reputation recently? It is a principal-protected vehicle that is backed by fixed income assets,” Graef concludes. “There are certain restrictions on stable value at the plan level. Those restrictions might have discouraged plan sponsors. Also, if your investors are using stable value exclusively, that might not be the best allocation. Vanguard has always advocated for a well-diversified portfolio. Lastly, wrap providers were stressed and capacity was therefore down, but the market has since recovered.”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
