A new derivative-based investment wrinkle - the alpha GIC - is making its presence known in the staid stable value repertoire.
And as was the case with new GIClike vehicles such as synthetic GICs and bank investment contracts, the alpha GIC has drawn a fair amount of cautious criticism.
An alpha GIC involves wrapping an actively managed bond portfolio, and then swapping portfolio returns to a third party for a specified benchmark return similar to a traditional GIC. If the manager outperforms the index, a portion of the excess alpha is returned to the plan.
According to Bruce Vane, senior vice president at Certus Asset Advisors, New York, the alpha GIC is "unlikely to add value" even though it might have some "upside potential."
"By the time you get done explaining how an alpha works for the standard corporate (plan sponsor), they usually find traditional GICs or synthetics are simple," he said.
According to Mr. Vane, the alpha might be fraught with event risk, liquidity risk, yield risk and volatility risk when compared with traditional guaranteed investment contracts or synthetics.
The key to gaining benefits from the alpha GIC is consistent outperformance by the money manager relative to the established benchmark, said Mr. Vane. Statistically, less than half of the manager universe outperforms the market annually.
"The alpha GIC can be positive or negative, and you are counting on consistent performance by the money manager; you can get all of the benefits of the alpha with a traditional product," he said. "Because some money managers can perform some of the time, none of them can do it all the time."
Some pooled GIC funds and large plan sponsors have considered the concept, but most traditional stable value managers are shying away, calling the strategy too complex and risky.
"If the bond manager doesn't outperform the index, you lose," said one GIC manager who declined to use the product.
"It is one of the most convoluted things ever to happen to the GIC world," said Bruce Goode, vice president-fixed income management at Society Asset Management, Cleveland.
Karl Tourville, principal and senior portfolio manager at Galliard Capital Management, Minneapolis, which oversees $1.8 billion in pooled stable value assets, said he believes there is a place for alpha GICs.
Mr. Tourville said alpha GICs are "not that hard of a concept to grasp." It "just allows you to take advantage of excess returns generated by the money manager's expertise and transport that to a type of maturity structure." While Galliard hasn't used the alpha product, "it is certainly something that we would look at," he said.
Noting active bond management fees average 30 to 40 basis points and swap fees are another five basis points, Peter Bowles, president of Fiduciary Capital Management, Woodbury, Conn., said an alpha GIC starts out 45 basis points behind a conventional buy-and-hold contract. He also pointed out nearly 75% of active bond managers failed to outperform limited- and intermediate-duration indexes in 1996.
The initial reluctance to use a new instrument mirrors that of other stable value investment vehicles developed over the years. There was reluctance to use bank investment contracts in the 1980s, and more recently with synthetic GICs, which have captured nearly half of GIC placements in recent years. Synthetics now comprise nearly 50% of all pooled stable value assets, according to Hueler Analytics Inc,. Minneapolis.
