Ever since the SEC upgraded its rules for money-market funds last fall, retirement plan advisers have been giving stable value funds a second look.
By mandating that nongovernment money funds introduce special fees, redemption restrictions and floating net-asset values, the Securities and Exchange Commission has given advisers a reason to reassess the cash management options in company-sponsored plans.
Stable value funds, which seemingly have been been around forever but
suddenly look new again, are a cash management option often compared with government money funds and the prime money funds that were subject to the
rule changes last October.
Like money-market funds, stable value funds typically are used as a proxy for allocations to cash. But depending on the age and circumstances of individual retirement savers, the investment could be as high as 25% of their retirement account.
With that in mind, advisers can't afford to take cash management options lightly, especially since most plans don't include more than a single choice for what is often described as "safe money."
PORTFOLIOS WRAPPED IN INSURANCE
Stable value funds, which can only be offered on the menus of company-sponsored retirement plans and 529 college savings plans, are basically bond portfolios wrapped in insurance contracts.
Unlike money-market funds,
which are regulated by the SEC, stable value funds are regulated under banking and insurance laws, including some state-level regulators.
The biggest single distinction between stable value funds and money funds is the yield, which can represent a gap of 100 basis points or more.
As historically low interest rates hold money fund yields down to around 50 basis points or lower, it's not uncommon for stable value funds to be yielding 1.5% net of fees.
But as with any investment, the higher yield should be interpreted as higher risk, which is something most investors are not looking for when it comes to their safe money.
"The new regulations continued to make stable value funds appealing relative to money-market funds," said Chris Karam, chief investment officer at Sheridan Road Financial, which advises on more than $12 billion in employer-sponsored retirement plans. "But you have to be able to do the due diligence on stable value funds, because you need to judge the performance relative to the riskiness of the underlying portfolio."
Of the more than 250 retirement plans under Sheridan Road's advisement, Mr. Karam said 95% include some form of stable value offering.
12% OF RETIREMENT ASSETS
According to the Stable Value Investment Association, approximately $821 billion is invested in stable value funds, or almost 12% of the estimated $7 trillion in retirement plan assets.
$821B
Amount invested in
stable value funds
That is up from a recent low of 10.4% in 2014, but down from the peak of 19% leading into the height of the
financial crisis in 2008.
"A lot of providers have gotten out of the stable value space since 2009 because they're the ones bearing the underlying investments decline," said Sean Deviney, director of retirement planning at Provenance Wealth Advisors, which advises on $1.9 billion.
"You need to evaluate the funds by looking both at the credit quality of the underlying investments and at the credit quality of the issuer," he said. "You need to understand the risk and be comfortable with it."
There are two main types of stable value funds: collective investment trusts and direct contracts.
Both are bond portfolios wrapped in insurance contracts to guarantee stable value and a certain yield, but a collective investment
trust diversifies the risk across multiple insurance contracts, while direct stable value funds are insured directly by the issuer's own balance sheet, essentially becoming their own guaranteed investment contract.
The second option usually pays a higher yield but introduces the risk of a default by the issuer, which is where some firms got into trouble during the financial crisis.
"In a direct contract that is backed by the general account of the insurance company, you are fully exposed to a single company," said Todd Stewart, director of investment research at SageView Advisory Group. "The bond portfolio manager is trying to invest conservatively in high-quality bonds that gain value and can support a high [return], but they also want those bonds to be stable."
In a
collective investment trust, the diversification is enhanced by multiple insurers backing different slices of the same portfolio.
"The only reason to go the general account route is typically for the higher yields, because you are taking on more risk," said Michael Esselman, director of investments at 401(k) Advisors. "You might get an extra 30 basis points of yield, but if the insurance company goes bankrupt you have to stand in line along with everybody else."
RESEARCH, MONITOR
According to Mr. Stewart, every new insurance contract has to be researched and monitored. "Each insurance contract determines how the stable value fund portfolio can be invested," he said. "And each contract can have different guidelines, even in the same fund."
There are clearly a lot more moving parts than one finds in a plain vanilla money-market fund, but some plan advisers insist it is worth the effort as long as it is providing retirement savers with a better risk-adjusted return.
According to Callan Associates, 64% of plan sponsors made changes to money-market options in the two years leading up to the October rule changes.
Of the employers that changed or replaced their money fund, nearly 13% added a stable value fund and 61% adopted government money funds, which were not affected by the rule changes.
If there hasn't been a race toward stable value funds since the October rule change, it is likely because many plans had been adjusting gradually
over the past few years.
"The October rule was an additional boost for stable value, but stable value had already been mostly favored relative to money markets as an option on a DC plan," Mr. Karam said.
