By Randy Myers
The interest-rate environment has been challenging for stable value funds over the past two years, but wrap providers and portfolio managers who spoke at the 2024 SVIA Fall Forum in October contend this is actually a good time to be promoting the asset class and its role in capital preservation.
The challenges to the asset class have been well documented. A sharp uptick in short-term interest rates from early 2022 through mid-2023 sent money market fund yields soaring and helped drive cash flows out of stable value and into that competing asset class. As expected in a rising rate environment, stable value market-to-contract value ratios fell significantly, challenging stable value managers working to meet participant withdrawal requests. Still, said Jo Anne Ferullo, portfolio manager and co-head of stable value strategies for Franklin Templeton Fixed Income, “We believe plan sponsors, consultants and advisors should be revisiting what’s going on with capital preservation.”
Ferullo explained that plan participant populations are aging and that older participants boast larger account balances. And with older participants often focused on generating income from their savings, capital preservation has become a bigger part of retirement plans than it was in the past. (Ferullo also noted that older participants tend to invest more heavily in stable value than younger participants because it is typically less volatile than other asset classes.)
Given all these developments, Ferullo argued that stable value continues to play an important role in capital preservation even if money market funds currently offer a yield advantage. After all, stable value returns historically have exceeded money market returns over the long term. Also, the Federal Reserve’s September cut in short-term interest rates—with more likely on the horizon—will help narrow the current advantage held by money market funds.
Still, retirement plan committees often require long lead times before making changes to plan design or investment menus. Accordingly, Ferullo said it’s important that the stable value community initiate conversations about capital preservation with them sooner rather than later. Her own firm has been doing just that, and now one of its plan sponsor clients is about to begin an educational campaign on the topic for its plan participants.
Ferullo was joined in a wide-ranging panel discussion by moderator Jessica Cole, head of stable value wrap contract management at Invesco; Bill McLaren, stable value business leader for the retirement plan services business at Lincoln Financial; Brad Bennett, senior portfolio manager for stable value strategies at Insight; and Paul Curran, director in the interest rate division of Citi Global Markets.
The panelists agreed that despite the challenging environment of the past two years stable value funds have continued to perform as intended, in part due to safeguards built into their design. Both Ferullo and Bennett pointed to the liquidity components of their stable value portfolios that helped them fund participants’ withdrawals and avoid the need for material changes to their stable value strategy.
Bennett also noted that there is ample wrap capacity in the industry, even though two wrap providers have recently been reducing their exposure to the business. Ferullo sees a silver lining in that move, arguing that it represents an opportunity for smaller providers to grow their wrap businesses and new providers to enter the market.
At least one bank—Citi—has already stepped into the breach. Curran said Citi sees stable value as a “good anchor product” with opportunities for growth. He explained that many banks exited the wrap business after the 2008 financial crisis as part of their efforts to meet new and more stringent regulatory capital requirements. That left the wrap market largely to insurance companies.
“We think (stable value) managers might appreciate having a different industry credit in their (wrap) portfolio versus having a high concentration to insurance companies,” Curran said. He added that Citi has been able to continue building its book of business while sticking to its principles, which center around investing in high-quality fixed-income securities and maintaining strong underwriting standards.
To be sure, the market environment for stable value over the past two years has had some impact on the stable value industry and its customers. McLaren noted that some plan sponsors who moved retirement plans to new recordkeepers were surprised to find that their stable value fund could be subject to a negative market value adjustment due to a low market-to-contract value ratio. This meant investors in the stable value fund could receive less than 100 cents on the dollar. However, he noted there are strategies for neutralizing the impact of those market value adjustments.
McLaren also said Lincoln Financial has been working with plan sponsors, consultants, advisors and participants to emphasize the long-term benefits of stable value, with some positive results. For example, the firm recently won new stable value clients despite the challenging market conditions.
Asked near the end of the panel discussion how plan advisors are reacting to discussions about capital preservation—and about moving clients from money market funds into stable value funds—Ferullo reported mixed outcomes.
“The idea of revisiting capital preservation is getting a lot of traction,” she said. “We’ve put out a couple of different papers on it … and people are reading (them) and understanding it now matters. The money market versus stable value discussion is much harder.”
Ferullo mentioned that one of her firm’s clients offers both stable value and money market funds to its plan participants and wants to move to just stable value—but also wants to wait for a “more normalized” interest-rate environment before making such a change.
“It’s a hill to climb right now, but we still have the data and performance on our side to make that argument (in favor of stable value),” Ferullo said. “And we’re going to keep making it.”
