Representing approximately $844.3 billion in retirement assets, stable value strategies remain one of the largest allocations in defined contribution (DC) plans.1 Jennifer Gilmore, CFA, Head of Stable Value Portfolio Management at Invesco, discusses how the segment has evolved, what to look for in stable value manager selection and how plan sponsors are effectively using these strategies to help stabilize participant outcomes – both currently and with an eye on emerging trends.
Q: How have stable value funds performed in the midst of recent market volatility?
A: The stable value industry as a whole has entered this pandemic crisis period from a much stronger position. Compared to the global financial crisis in 2008-2009, wrap contract issuers today are more committed to the market and stable value fixed income portfolio investment guidelines are generally more aligned with the goal of principal preservation. We continue to monitor market events closely as we navigate this unique situation. Over the short-, intermediate- and long-term, we expect stable value portfolios to continue delivering on the objectives of principal preservation and providing an attractive crediting rate to participants.
Q: What role does stable value currently play in the DC market?
A: Stable value solutions continue to fill two important roles in current plan design. The first is principal preservation. The asset class has a proven track record across market cycles of delivering capital safety, cash-like liquidity and reduced volatility compared to other fixed income alternatives. The second is strong risk-adjusted returns. The category offers a solid history of generating consistently positive returns that, over the long-term, are more in line with intermediate-term bonds but with volatility comparable to money market funds. Together, these benefits can offer participants a significant risk/reward advantage that can help add a stabilizing component to potential retirement outcomes, and ensure capital preservation assets are adding as much value as possible.
1Source: SVIA website as of December 31, 2019.
2The Callan DC Index as of December 31, 2019.
Q: How has the asset class changed over the past decade?
A: The basic objectives of the asset class have not fundamentally changed, but there are different products available that seek to deliver on these objectives, and each has evolved in its own way. Plan sponsors typically access the strategy in one of three ways: as separately managed accounts, commingled funds or guaranteed insurance accounts, depending on the plan’s size and specific needs. For Invesco, our focus is on an approach that generally consists of a diversified, high-quality fixed income portfolio “wrapped” by investment contracts issued by banks and insurance companies that provide book value accounting, which reduces return volatility. This allows the strategy to maintain a steady one-dollar-per-share net asset value while pursuing the higher returns from the underlying bond holdings relative to other capital preservation offerings.
The biggest area of transformation over the past 10 years probably has been in the wrap issuer market. Similar to many other investment products, stable value was intensely stress-tested by the 2008 financial crisis, ultimately moving to an even stronger position because of the lessons learned during that extreme period. Throughout the crisis, the segment continued to deliver on its primary objectives of principal preservation and delivering consistently positive returns. However, in the years following, many wrap providers reassessed their business strategies and adjusted their contract offerings with more updated investment guidelines and contract provisions. Others decided to exit the business altogether.
Going through this process has left the market with a healthier, more robust group of wrap issuers. New entrants and increased business appetite from established providers have also helped to alleviate the underwriting constraints that were experienced directly following the crisis. Today, there are more wrap issuers available than Invesco observed in 2009 – offering ample capacity to meet stable value demand. The industry also has seen a general 25% to 40% decline in wrap contract expenses from the spike following the crisis.
Q: How important is product selection with stable value?
A: Manager selection can be very important given the number of solutions in the marketplace. Because stable value strategies are viewed as such conservative investments, it can be easy to forget that they are actually quite complex products to manage. What they tend to have in common are similar objectives, but how they pursue these objectives can be quite different. This, in turn, can result in notably different investment experiences, particularly as market cycles evolve.
Given these wide variances in investment approaches and portfolio structures, selecting a stable value solution demands the same depth of rigorous evaluation and ongoing monitoring as any other asset class. It is important to work with a proven manager who understands the plan’s unique goals and needs, and what it takes to achieve those objectives.
Q: What are some of the key differences to consider?
A: The main differences stem from product structure, fixed income portfolio management and wrap contract strategy. Some core considerations include:
- Single- versus multi-wrap issuer structures: Having diversified wrap issuers can help reduce default risk and have a positive impact on negotiating leverage while a single issuer approach can help streamline due diligence. The need for diversification may vary by plan, and the evaluation should incorporate an understanding of the actual exposure generated from the product (for insurance company general account products, there is an increased exposure as compared to a strategy that incorporates a combination of fixed income holdings and wrap contracts).
- Underlying portfolio risk levels: If the product structure incorporates fixed income portfolios, is the plan sponsor comfortable with the amount of risk being taken in the portfolio? The market includes a range of risk parameters across strategies, which may have significant impact on both short- and long-term performance, depending on how conservative or aggressive the fixed income portfolio is constructed. For example, relying on 100% US Treasury exposure might help ensure a portfolio achieves principal preservation, but it leaves meaningful credit return potential on the table. Conversely, too much credit risk may start to increase return volatility and potentially sacrifice preservation safety. It is really about understanding the right balance for the individual plan.
- Fixed income manager diversification: Some strategies are structured with a single investment manager responsible for the entire fixed income portfolio. Others employ a multi-manager approach to incorporate different investment styles and distribute manager risk. There are also managers with the flexibility to construct a strategy with either approach, depending on a plan sponsor’s preferences and needs. There is typically a relatively small additional cost that is associated with additional manager diversification that should be considered within the context of targeted outcomes.
- Contract selection and negotiation: Contracts are individually negotiated instruments, and provisions can vary in areas such as termination and covered withdrawal activity. Potentially, these may need to be reconsidered over time as the marketplace evolves to ensure stable value investors benefit from updated provisions.
- Payment support: Plan sponsors should understand what assets are backing the payment obligation for their stable value investment and how this may affect issues such as transparency, portability and potential risk exposures. Products range from those that have 100% exposure to an insurance company’s general account to those that support this liability with a fixed income portfolio that is held in the name of the plan.
- Exit provisions: There are a variety of exit provisions in the market today, and it is important to be aware of any potential hidden costs or whether any return premiums or fee savings might come with lengthy lockups in order to receive book value.
One of the primary tenets in our own stable value management style is the belief that diversification at multiple levels—across wrap issuers, fixed income issuers and fixed income sectors and subsectors—leads to better outcomes for our investors. How we approach that in terms of managing individual risk/reward exposures, portfolio holdings and whether to employ a multi- or single-manager structure will depend on the unique goals and needs of each plan.
A: We expect stable value will continue to play an important role in helping participants to safely accumulate retirement savings. The capital preservation and higher return characteristics offered by these strategies offer obvious benefits to those approaching or in retirement, but even younger investors may find an allocation useful in helping to maximize risk-adjusted performance as part of a well-diversified portfolio.
Currently, plans primarily offer stable value as a standalone investment menu option. As we look at plan design advancements, however, some early-adopters have started to utilize the asset class in their custom target-date fund glide paths in order to help optimize outcome potential. Retirement tier applications are also an interesting area of innovation, given stable value’s seemingly natural fit as a valuable component of possible retirement income solutions. It is exciting to see the asset class, which has served plan sponsors and participants so well through the decades, begin to expand into these additional areas of application.
Q: What characteristics should plan sponsors look for in a manager?
A: When evaluating or monitoring a strategy, it is important to consider how effective the manager will be in balancing the principal preservation and return components of stable value through multiple market cycles. Look for:
- Experience in fixed income and wrap contract management: A manager should offer a depth of expertise and consistency in both of these areas, including being well equipped to navigate a full spectrum of possible investment In addition to the stable value investment team, plan sponsors should consider the capabilities of the broader credit research and fixed income resources that support it as well.
- Portfolio and platform flexibility: The universe of plan sponsors is diverse, and there often is not a one-size fits-all solution with these products. The right manager should be able to offer a thoughtful approach to portfolio design that can meet the specific needs of a plan’s participant base, risk preferences, fee sensitivity and legal structures, and be able to adjust as they evolve over time. Portability across DC recordkeeping platforms is another very important issue to consider.
- Robust, transparent reporting: What type of reporting is available, and is it consistent regardless of selected product structure? Does it include tracking of all fixed income exposures? This type of integrated oversight platform is particularly essential in multi-manager solutions.
- Potential red flags: One of the last places plan sponsors want to be exposed to portfolio uncertainty is in their stable value strategies. Consequently, any major changes in core areas such as investment team, process or performance should quickly trigger closer evaluation.
Keep in mind that stable value offerings are subject to unique dynamics and attributes that simply are not found in other asset classes. As such, it can be extremely useful to work with a manager with a consistent, long track record of success in the segment.
To learn more about stable value investment considerations or Invesco’s stable value solutions, visit www.invesco.com/DC/stablevalue or contact your Invesco representative.