Testimony Of Kelli Hustad
Ms. Hueler is the Founder and President of Hueler Companies, an independent consulting firm assisting plan fiduciaries and trustees with research, product selection, and ongoing oversight of their stable value investment funds. Hueler Companies tracks approximately 85% of professionally managed stable value pooled funds. Based on that research, Ms. Hueler defined a Stable Value Fund as a diversified pool of high quality, fixed-income instruments constructed with insurance company or bank contractual agreement. These contracts, which are fundamental to the construction and function of stable value investment funds, transfer risk away from the individual either to the issuing entity or through crediting rate mechanism designed to spread fluctuations of principal over time. This risk transfer protects participants from losses due to market volatility and interest rate shifts.
Since the 1980’s, these funds have produced significant benefits for participants in qualified plans, which explains why many plan fiduciaries offer this option and why many plan participants choose the option. Even amidst the recent economic turmoil, Stable Value Funds have provided a safe-haven for millions of participants in a volatile market.
Principal Risks Of Investing
- The possibility of default by or deterioration in the creditworthiness of the investment contract provider
- The possibility that the investment contract will no longer provide book value coverage as a result of a breach of the contracts terms or the occurrence of certain events affecting a plan or its sponsor
- The fact that costs incurred by the Fund to purchase the investment contracts will reduce the Funds return, possibly preventing the Fund from performing as well as other high quality fixed-income funds of comparable duration
- The possibility that the Investment Manager will be unable to replace an investment contract, in the event that it is terminated, with an agreement having at least as favorable terms and/or costs
- The risk that securities owned in the Fund may become impaired under the investment contracts and have to be sold or marked to market at a time when the securities value is especially low, thereby reducing the market value of the Fund
- The risk that the Funds market value performance has a negative impact on the Funds crediting rate or the ratio between the market value and book value of the Fund portfolio such that the contract issuer may exercise certain rights to terminate the contract or direct the management of the Funds investments, which could materially impact the Funds performance and
- The risk that greater use of separate account investment contracts creates greater exposure to the insurance companies issuing those contracts.
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Different Types Of Stable Value Funds
Stable Value Funds are managed in different ways, including:
- Separately managed accounts are customized to meet the objectives of a single retirement plan and do not include assets of other plans.
- Commingled or Collective Funds. These accounts are designed to combine the assets of unrelated retirement plans, enabling the investor to diversify and gain the economies of scale.
- Guaranteed insurance contracts . These investments are another managed arrangement in which the fund manager holds or invests in a single group annuity contract issued directly to the retirement plan and the plan sponsor receives a direct guarantee of principal and accrued interest from the issuer.
An important component of a Stable Value Fund is an insurance contract-known as “wrap contracts” or “wrappers”-that plan sponsors purchase from banks, insurers, or other financial companies. The wrappers generally guarantee that participants will receive principal and accumulated interest even if the bonds held in a fund’s portfolio decline in value. In other words, the plan participants are able to transact at book value rather than at the more volatile market value. Generally, if a stable value portfolio falls below the rate of return set by the wrapper, the insurer pays the difference.
Invesco Stable Value Portfolio
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Testimony Of Jason Scott Financial Engines Retiree Research Center
Financial Engines is an independent investment advisor offering advisory services to plan participants through their employers. Jason Scott, Managing Director of the Retiree Research Center at Financial Engines, stated FE utilizes Stable Value Funds in their recommended participant allocations – $1.5B is currently invested in Stable Value Funds out of their $20B under management.
A Stable Value Fund is a fixed income investment vehicle made up of two components: 1) an investment fund managed by an investment manager, and 2) an insurance contract designed to guarantee returns over a short period and to also permit participants to transact at book value. The higher returns come with the trade off of potential liquidity issues and possible restrictions imposed by the wrap provider on the plan sponsor. These restrictions can create challenges impacting plan sponsor decision-making and actions.
Wrap contracts are designed to cover all individual initiated redemptions, but not employer initiated redemptions. Recent market volatility leading to lower market values significantly below book value has increased scrutiny on plan sponsor behavior that might be considered employer initiated. The following could be considered employer initiated:
- Terminating a plan
- Replacing an underperforming Stable Value Fund
- Communicating any information to participants that may result in incremental redemptions
Mr. Scott made the following suggestions:
Testimony Of Douglas Prince Stifel Nicolaus
Douglas G. Prince is a Managing Director with Stifel, Nicolaus & Company, Incorporated, an independent investment advisory firm serving qualified retirement plans. Mr. Prince testified that Stable Value Funds are a common investment option in retirement plans and have been in existence for a number of decades. He also stated he thinks they will continue to be offered in participant directed plans in the future, even though the recent economic crisis has brought attention to the way Stable Value Funds are managed. He thinks that Stable Value Products should continue to be available, but he suggests there should be more disclosure about the construction, makeup, fees, and risks of these funds so plan sponsors and participants can make more informed decisions.
The risks to Stable Value Funds include 1) Insurance risk, 2) Investment risk, 3) Employer Risk, 4) Income risk, and 5) Lack of insurance contract wrap capacity. These risks can be mitigated through more transparency in the system and a more standard method of reporting results and portfolio holdings.
Mr. Prince does not believe Stable Value Funds are a suitable QDIA for long-term investment allocation since there is no diversification. For plans with automatic enrollment and significant turnover in the first few years of employment, he does think it might make sense for those participants with a short time period in the plan.
The best practices tool should contain the following:
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Testimony Of Kathryn Solley And Linda Haynes Seyfarth Shaw Llp
Ms. Solley and Ms. Haynes are partners at the law firm of Seyfarth Shaw LLP. They reviewed challenges of selecting, monitoring, and communicating Stable Value Funds in DC plans. While some larger 401 plans offer SVFs through the separate accounts, most offer a commingled fund. Stable Value Funds are commonly viewed as comparable to money market mutual funds, but differ significantly. There are specific legal restrictions on the securities in which a money market fund may invest while Stable Value Funds have no restrictions. By law, money market funds may only suspend redemptions in very extreme situations while SVFs have no restrictions.
- Most plan fiduciaries lack the power to negotiate special terms to protect their plan participants or the fiduciaries themselves. The level of due diligence for Stable Value Fund selection is qualitatively different from the due diligence in selecting a mutual fund. Unlike mutual funds where there is a variety of sources regarding their current and historic value, the only source of Stable Value Fund information is the vendor. Even so, 401k investment options are potentially unique to each plan. Therefore, a new Department regulation would be problematical and perhaps unduly restrictive. “Best practices” guidance and factual information would be helpful.
How To Invest In A Stable Value Fund
Stable value funds are only available to participants in 401 plans and other defined contribution retirement plans. Thats important to be aware of because if you roll over a 401 to an individual retirement account you wont find a stable value fund offered by the brokerage where you have your IRA.
That said, just because you have a 401 doesnt mean youll be able to invest in a stable value fund. According to the Plan Sponsor Council of America, more than 30% of plans lack stable value fund offerings, though this number shrinks for larger plans with at 1,000 participants.
When looking to see if your 401 offers stable value funds, keep in mind that they come in a variety of names. Look for fund names that riff on terms such as principal preservation, capital accumulation or guaranteed income.
When you find a fund, be sure to check the annual expense ratio. Given the added cost of the insurance component in a stable value fund, the expense ratio may be higher than the cost of a comparable core bond fund. Thats not necessarily a deal breaker. But if theres a wide gap you need to decide if its worth the extra cost for the security a stable value fund provides.
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How Risk Is Managed
The holdings within stable value funds are more susceptible to changes in interest rates than money market holdings because of the longer maturities of the bonds in which they invest.
The share price of stable value funds doesn’t have the potential to grow over time, but these funds won’t lose value either, which is not the case with typical mutual funds.
This risk is mitigated by the purchase of insurance guarantees by the fund that offset any loss of principal these guarantees are available from banks and insurance carriers. Most stable value funds will purchase these contracts from three to five carriers to reduce their default risk.
Usually, the carriers will agree to cover any contracts defaulted upon in the event that one of the carriers becomes insolvent.
How Stable Value Funds Fit Into Your Retirement Portfolio
Matthew Schwartz, a certified financial planner at Great Waters Financial in Richfield, Minn., suggests that stable value funds can be used as a complement to bond funds in your portfolio. While core bond funds can lose principal during periods of rising interest rates, those dips are typically small and infrequent. Moreover, if you switched your bond holdings exclusively to stable value funds, youd miss out on gains when bonds rally.
We want to be able to capture some of the principal appreciation that a bond fund can have when interest rates are decreasing, says Schwartz. A stable value fund doesnt give you that upside when rates are falling. That stable is stable.
Ultimately, though, how much of your bond allocation you might want to move into stable value funds is a matter of personal choice, based on your risk tolerance. If you really hate the idea of any price volatility, you might want to invest more of the fixed income portion of your portfolio in a stable value fund than in a core bond fund.
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Testimony Of Susan Graef Vanguard
Susan Graef is head of the Stable Value Management Group at Vanguard. Vanguard manages over $27 billion in stable value funds for approximately 1400 institutional defined contribution plans. These assets are managed either in commingled pools or as client separate accounts.
Ms. Graef began her testimony by describing Vanguard’s disclosures for stable value funds. Vanguard believes that different disclosures should be used for plan sponsors and plan participants as plan sponsors require additional information to perform their fiduciary duties. She recommended that the Department provide a best practices or Q& A type of educational piece that would explain stable value basics and include the following points:
- Stable Value Funds are not a substitute for money market funds but rather a short- to intermediate-term fixed income fund alternative.
- Stable Value Funds can pay off at less than book value on account of “plan events” such as significant layoffs, divisional sales or plan sponsor insolvency.
- In addition to considering book value/market value differences in evaluating Stable Value Funds, plan sponsors should look at the credit quality guidelines of the fund’s portfolio manager as well as the fees and sales charges involved with the fund.
- Plan sponsors should be aware of the implications if the sponsor wants to change the plan’s stable value option.
In response to other questions from Council members, Ms. Graef stated that:
What Are Stable Value Funds
The Council received significant testimony concerning the purpose, design and features of Stable Value Funds. Though there are differences among various Stable Value Funds in general, a Stable Value Fund can generally be labeled as a conservative, fixed income investment vehicle with an objective of preserving capital while providing a relatively stable rate of return that generally exceeds the returns provided by money market funds.
Frequently, a Stable Value Fund is a fixed income investment fund managed by an investment fund manager with a wrap contract that guarantees book value to participants for participant-initiated events, such as transfers to other investment options and plan distributions.
Fund managers typically invest in highly rated corporate debt and highly rated structured securities such as asset-backed securities, commercial mortgage-backed securities, residential mortgage-backed securities, and other similar fixed income investments. The fair market value of these Stable Value Funds fluctuates on a daily basis, but their book value or net asset value does not fluctuate.
Overall, it is clear that Stable Value Funds are an important investment tool for retirement plans covered by ERISA, especially in participant-directed retirement plans, such as 401 plans. Stable Value Funds are an important tool in achieving a conservative, fixed income return while preserving capital.
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Testimony Of James King Jr Prudential
Mr. King started his testimony by noting that the events of the last twelve months have underscored the importance of offering safe investment options in retirement savings vehicles such as defined contribution plans. Stable value products, with their relatively high returns, low volatility, and protection features such as capital reserves to back guarantees, provide a compelling solution and it is essential that they be classified as a qualified default investment option. Stable value products offer participants safety of principal and the ability to withdraw funds at book value while providing higher levels of returns than an intermediate bond fund and volatility similar to that of money market funds.
The unique insurance protection in Stable Value Funds allows them to deliver high returns with low volatility. Stable Value Funds combine an investment with an insurance contract that guarantees return of the investor’s principal and accumulated earnings. Principal balances grow at the crediting rate promised by the Stable Value Fund provider.
Stable Value Funds minimize risk by investing in high quality securities and by providing an insurance contract that promises the return of participants’ principal and accumulated interest earnings whenever they wish to redeem their investment even if the actual market value has declined.
Testimony Of David Wray Profit Sharing/401 Council Of America
Mr. Wray began by describing the attributes of the typical Stable Value Fund and by noting that Stable Value Funds have performed extremely well in the recent difficult economic times. They have met their principle guarantee commitments and have exceeded the return expectations when compared to money market funds. While there has been some concern about the market-to-book gap, the positive cash flow into these funds and the relative short duration of their underlying investment is closing the gap. And, while rising wrap fees have led to reduced net returns, plan sponsors are still finding that their participants benefit from the unique aspects of this investment.
PSCA urges that the Council not provide requirements or guidelines to plan sponsors and retirement service providers for the design or marketing of these investments. This would require the Department to impose its judgment at a set point in time, overriding accepted investment theories that are constantly evolving. This would also result in one-size-fits-all products and freeze innovation.
Mr. Wray said the Council should develop and publish lists of best practices for use by plan sponsors in the selection and monitoring of Stable Value Funds. The Council could ask the major investment-consulting firms for their suggested list of best practices and synthesize these lists.
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Testimony Of Nell Hennessy Fiduciary Counselors
Nell Hennessy opened her remarks by explaining how in her experience as a fiduciary, her firm has encountered many stable value situations and that employers do not have a clear understanding of the risks inherent in the stable value contracts. She stated that most employers see stable value as being roughly equivalent to the money market fund.
She said that many participants see the stable value fund operates like a savings account and, therefore, that they fail to see the risk that would be apparent if they knew the market value. From an employer’s standpoint there is also no clear realization of the circumstances in which they may not receive market value. Therefore, it would be useful to the plan sponsor community if the Department could develop a clear, neutral format that would explain the circumstances under which sponsors may not receive full market value.
Ms. Hennessy then discussed the crediting formula for stable value contracts, noting that while this may not be something to put before the participants, it is something that sponsors should have explained to them in clear, easy to understand, narrative form. She commented that in the past year, the stable value industry has done a good job in trying to minimize the exposure to interest rate volatility.
