As investment markets become increasingly unsettled and interest rates increase, participation in stable value investment products is growing, especially among older retirement plan participants who are looking for fixed-income capabilities. Therefore, we believe it may be a good time for a frank discussion about stable value products and how retirement plan committee members select and monitor such options for their plan investment menus.
Background
Most defined contribution plans include some type of stable value product1. In general, their key features of
- Principal preservation,
- Historically consistent, positive returns and
- Liquidity for participant benefit payments
make them a popular plan menu item. Of late, they have become plan participants’ vehicle of choice for capital preservation in 401(k) plans. Stable value funds took in 82 percent of 401(k) trading inflows in June 20222. (Outflows were from target date, large U.S. equity and international equity funds.)
A stable value fund is a bond portfolio that is “wrapped” with a guarantee so that changes in the market value of the underlying bonds are offset by a short-term credit facility. This enables investors to withdraw money at par value, thereby having the potential to insulate plan participants from day-to-day market volatility. Because of their use in a retirement plan environment, they are valued using a contract value accounting method approved by the Financial Accounting Standard Board (FASB) rather than the mark-to-market accounting required for most other investments. This accounting standard allows stable value products to potentially steady the returns earned by plan participants and hopefully insulate them from daily market volatility. As a result, stable value products tend to be less volatile than other asset classes.
Like any other investment product, however, there are inherent risks to stable value products. For example, if the market value of a stable value product is significantly below its book value, a stable value product may be unable to meet benefit obligations. Another risk factor is an inflationary cycle and a rising interest rate environment. Over the short term, the rates paid by stable value products tend to lag behind other rate-sensitive products. Over the long term, as a result of the longer duration of the bonds held in the underlying portfolio, stable value products in general have been able to pay higher rates than money market funds since their development in the late-1970’s.
However, since the stable value market has never experienced an extended period of time where interest rates continued to rise, as occurred from 1955 through 1981, we believe it is justifiably worthy for fiduciaries to consider that potential risk and the impact that may have on their retirement plan participant accounts.
Choosing Wisely
Picking an appropriate stable value option for a retirement plan is tricky. And, unfortunately, plan officials often approach stable value fund assessment with faulty assumptions due the lack of clear understanding of what a stable value fund is. Moreover, few plan committees have an appreciation for the subtle nuances and differences between stable value product types (there is more than one).
Consider, for example, the typical plan investment vetting process a plan committee uses when considering several large cap value funds for the plan. Likely, the committee will look at returns, manager tenure, costs and, perhaps, alpha and beta. The presumption is large cap value funds are homogeneous in many respects.
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