Are Stable Value Funds Getting Shakier?

Copyright 2009 Institute of Management & AdministrationAll Rights Reserved Managing 401(K) Plans

June 2009

HUMAN RESOURCES Vol. 2009 No. 6

1257 words

Are Stable Value Funds Getting Shakier?

Main article

No investment fund has gone unscathed with all the financial turmoil that has overtaken the market over the past 12 months. And stable value funds are no exception.

"It is a perfect storm that we have seen happening in so many different areas of the market in the past 12 months or so. Most stable funds are set up where there is an underlying fixed-income portfolio that is then wrapped in a contract with a financial institution, which guarantees certain things so you can microkeep for the fund on book value versus market value" noted Linda Haynes, a partner with Seyfarth Shaw LLP in Chicago.

With everything that has been going on in the market, the value of that fixed income portfolio has dropped significantly, she added. So there is a big difference in a lot of portfolios between the market value of the fixed-income portfolio and the book value for the fund, she added.

And with all the consolidation that has been going on with financial institutions and financial institutions' concerns about their own balance sheets and businesses, the financial institutions that are willing to continue to provide those wrap contracts is shrinking. "Right now, it is really a seller's market, and there really aren't very many who are willing to enter into new arrangements," Haynes said. She added that if there is an existing contract, they are living up to that contract. But if a plan sponsor would like to replace a provider or if the sponsor's contract is expiring, it's a "real struggle right now to find a replacement."

"Even a stable value fund that was investing in AAA securities was going to feel the impact of what has occurred," added Kelli Hueler, CEO of Hueler Analytics (Minneapolis).

If you look at what Moody's and S&P have done to the credit ratings of the securities that they were holding, of course stable value managers had to revise their portfolios and restructure some contracts. But that was the story from last fall, Hueler said. "We had wrap providers given what was happening in the marketplace with AIG and the concerns over the credit markets pulling back and constraining their capacity and evaluating their books of business."

But in Hueler's eyes that is not a negative; it's positive and proactive and should be expected. If you have professional asset managers running these portfolios, they are doing all the things they need to be doing to ultimately revise and restructure some of their holdings to match today's market, she continued.

"The benefit of these stable value funds is that they have such healthy cash flows that the managers are able to continually replace securities that have declined in credit, to come back into line with their credit guidelines. They can revise guidelines and continue to be purchasing securities that are more conservative in structure."

And while she admits that average market to book values did go down to about 95, they are already up to an average of 96. "If you give them maybe three more quarters, they will be back to where they were," she added.

There is no question that every fund, whether it is a money market fund or a stable value fund, has had to carefully evaluate the securities that they are holding; they have all had to make adjustments, she added. It's whether or not they are doing that and they are doing so in a prudent, proactive manner.

Even before any of the market difficulties, some wrap providers were looking at the stable value fund book of business and saying there is just not enough in it from a pricing perspective to offset the risk. There was already consolidation, and some wrap providers were already moving away from the market.

And with wrap fees now going up a little bit, more providers can make sense of the business from a risk perspective. "But what participant would argue that 10 more basis points for a wrap are not worth it when they have book value protection of their assets as the market declines?" Hueler asked. "An additional 10 basis points, when it makes the pricing side attractive enough for more wrap providers to compete and be part of the business, is healthy."

Advice for Plan Fiduciaries

Haynes recommends that plan fiduciaries who have either a stable value fund or a pooled fund within their investment offerings should ask the following of their stable value provider:

What is the current bear market value of the fixed-income portfolio to book? That is going to give them an idea of what the gap is, Haynes said. "I've seen funds where their fair market value to book is in the high 90s. I've seen others where it's in the mid-80s. There's a big difference. That's a very important question to ask because that will then give you an idea of where they are."

What is the provider's view of the fund's current situation and future?

What actions have they taken in response to everything that is going on in the market?

Are they planning to take any other actions?

"Those questions are key to get their arms around whether or not they might have a problem. If they get the answers to those questions and start feeling uncomfortable, then they should really consult with some financial experts to help them better understand what the situation is and whether or not there are actions that need to be taken," she added.

Hueler adds that plan sponsors should look at this as an opportunity to evaluate their stable value funds. Look at how the stable value fund has performed. Recognize that market-to-book ratio did decline, but should be now back on the rebound. "They should see their manager taking proactive steps to address the market-to-book ratio and to also address the given sectors that had difficulty after the rating agencies wrecked havoc with the debt markets," she warned.

Pooled Fund Yields

Hueler Analytics's most recent data on stable value pooled funds performance showed an average 12-month rolling return as of Dec. 31, 2008, of 4.24 percent, down -0.37 percent from Dec. 31, 2008.

Galliard Managed Income Fund was the leading performer in terms of 12-month rolling return, posting a yield of 5.01 percent as of March 31. ICMA-RC Vantage Trust PLUS Fund, meanwhile, was also a top performing fund with a return of 4.94 percent, followed by T. Rowe Price Stable Value Fund at 4.63 percent (see Exhibit 2).

As for the top three yielding pooled funds, Gilliard had the best credit quality at 8.05 (out of 10) followed by T. Rowe Price at 7.85.

The fund with the best credit quality was perfect 10 RiverSource Trust Stable Capital Fund with a yield of 4.10 percent.

For a list of stable value pooled fund provider contacts, see Exhibit 1.

Company Name
Contact
Phone Number
Fortis Investments (ABN AMRO)
James Pondel
(312) 884-2378
Charles Schwab
Kevin Bowman
(415) 667-3008
Federated
Marian Marinack
(412) 288-6328
Galliard
Karl Tourville
(612) 667-8033
Goode
Bruce T. Goode
(216) 771-9000
ICMA
Bill Roland
(202) 962-6953
Invesco
Chris Utz
(502) 561-3240
John Hancock
Rich Manewal
(617) 663-4721
JPMorgan
Pete Chappelear
(212) 648-2700
KeyBank
Victory Capital Management Inc.

Product Information
(877) 660-4400
M&I
Dave Komberec
(414) 287-8577
Standish Mellon
Lesley Zalewski
(415) 399-4478
Putnam
Brendan McCarthy
(617) 760-2603
Blackrock
Laura Powers
(609) 282-2109
Ameriprise (RiverSource)
Anne F. Holloran
(612) 678-4044
SSGA
Katie Pierce
(617) 664-3659
Bank of America
Lisa M. Linker
(617) 434-5762
T. Rowe Price
Travis Freund
(410) 345-5975
U.S. Bank
Brooks Lillehei
(612) 303-3453
Union Bank of CA
Gregory B. Lugosi
(415) 705-7607
Vanguard
Mark Dorfler
(610) 669-4696
Wells Fargo
Karl Tourville
(612) 667-8033

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May 26, 2009