Stable Value - Slow and Steady
Stable value funds have long been used as capital preservation investment options in 401(k) plans because they are designed to preserve capital while providing steady, positive returns. Long considered a conservative, low-risk investment, they are generally invested in a high-quality, diversified fixed-income portfolio and protected against interest rate volatility by contracts from banks and insurance companies.
The two basic types of stable value funds are: separately managed accounts, which are stable value funds managed for a specific 401(k) plan, and commingled funds, which pool together assets from many 401(k) plans. Despite the funds’ long history with 401(k) plans, advisers still have many misconceptions about them, including these five:
Stable value funds are interchangeable with money market funds and all pretty much the same.
There tends to be a total lack of understanding of what stable value funds are and why you would use a stable value fund versus a money-market fund, says Dorann Cafaro, a consultant with Cafaro Greenleaf LLC in Little Silver, New Jersey. “The average adviser,” she says, “has no idea that there is even more than one kind of stable value fund.”
Stable value funds also are not all the same; for example, floor interest rates, says Chris Cumming, Senior Vice President, Defined Contribution Markets with Great-West Retirement Services in Greenwood Village, Colorado. Group annuity contracts, he explains, generally have a minimum floor guarantee of interest rate paid on the investment in a fixed account. Often, older products—five years and further back—have floor rates of 3% or 4% because rates were higher, he says, and new contracts have a floor rate of 0%. So, moving to a new group contract may not be the best thing; interest rates are now lower and insurance companies have dropped the floor to 0% or state-required minimum on their new contracts, he says. Credit ratings also differentiate stable value options, says Cumming. Advisers need to consider the strength of the insurance company offering the fund and any fee wrappers around the product.
Insurance company separate accounts are secure.
People believe that insurance company separate accounts are protected in bankruptcy, says Chris Tobe, Founder of Stable Value Consultants in Louisville, Kentucky, which evaluates and does due diligence on stable value funds, and assists plans in manager searches and transitions. In reality, he says, insurance company separate accounts are less secure than most people think. When the economy sours, insurance company separate accounts act more like general accounts and less like synthetic separate accounts. Under a synthetic-based stable value fund, the participants actually own the underlying bonds, he explains. However, he says, with an insurance company separate account, while the insurance company may show the plan or participants a portfolio of underlying bonds, the plan participants really own an insurance contract, and the insurance company owns the bonds.
If an insurance company were to go bankrupt, says Tobe, owners of separate accounts have a better claim on the assets in those separate accounts than general accounts and other creditors, but still have at risk 100 cents on the dollar. With a synthetic stable value, since the investor owns the underlying bonds, the risk is only the difference between mark and book value, which is typically only 5 cents or less on the dollar, and even in the worst times only approaches 20 cents on the dollar. In reality, most synthetic stable value products use three or more synthetic GICs (guaranteed investment contracts), so investors’ risk exposure to the insurance company or bank is even less.
Competing investment options are not allowed, and equity washes are a big deal.
Many advisers believe that you cannot have a money-market fund in the plan that directly competes with the stable value fund. This is not true, says Cafaro; competing funds are allowed. However, if participants want to move money from a stable value fund to a money-market fund, they have to do an “equity wash.” An equity wash is when money is taken from a fixed-income option and reinvested in an equity option for a specified period of time, e.g., 60 days, then moved back to a similar fixed-income option. Equity wash restrictions prevent participants from transferring funds directly from a stable value fund into a money market fund.
Another misperception is that equity washes are a “big deal,” says Tobe. Most plans do not even have to deal with this issue since they offer just stable value and do not duplicate it with lower-yielding money market funds. It is believed that restrictions against equity washes are done because the insurance company wrapper makes more money, says Tobe. The reality is that equity wash restrictions protect stable value participants by preventing participants from arbitraging between stable value funds and money-market funds, he says. Arbitraging, he says, would harm participants remaining in the stable value fund and makes it riskier for the stable value issuers. Money-market funds, explains Cafaro, reflect market changes more quickly than stable value funds, so the restrictions are needed to keep participants from playing the two off each other.
Stable value funds will come back to bite you when it comes time to change recordkeepers.
Many advisers believe that stable value funds are problematic when changes have to be made to the plan, says Cafaro. They believe that, when a plan changes its recordkeeper, and the stable value fund was an option of the prior vendor, it is not liquid at a dollar-for-dollar rate or lower than whatever the current market value rate is. The reality is, she says, that most stable value funds have a put feature that provides for 100 cents on the dollar liquidation after a year. Most advisers, she says, do not understand that this option exists. Advisers still can move all the other assets to a new vendor immediately, she says, but advisers will just have to leave the stable value fund behind for a year. It does not affect the participants in any way, she notes.
When a sponsor has a stable value put feature, it informs the provider of the desire to put the fund back to the provider at par, i.e., 100% or dollar for dollar, and the provider usually then provides a letter informing the sponsor that their stable value put will be exercised on a date one year from the letter date, says Cafaro. Money would be frozen in the fund except for benefit payments. If the sponsor then changed recordkeepers, the new recordkeeper would treat this frozen fund as a note on the system until it was liquidated on the put date, she adds.
Stable value can be bought and forgot about.
In actuality, says Tobe, stable value funds, like any other investment on a plan lineup, have to be regularly monitored.
—Elayne Robertson Demby