STAMFORD, Conn. - IBM Corp. has restructured its $3.5 billion stable value fund, implementing a unique single global wrap for all synthetic contracts in the fund.
As part of the change, IBM hired State Street Bank & Trust Co., Boston, as custodian - with expanded duties - for the synthetic portfolio. Previously, State Street was custodian for three of the 12 accounts in the portfolio.
IBM executives made the change to position the fund for growth and to gain investment flexibility and tighter risk control.
Synthetic contracts are designed to resemble traditional guaranteed investment contracts with book value accounting, consistent returns and lack of volatility.
Usually, a plan sponsor hires a fixed-income manager to manage the underlying assets, then pays a bank or insurer to provide to the contract the book value wrap and benefit responsiveness.
That third party would incur a liability if a withdrawal occurs when the underlying portfolio's market value is below its book value, but only for the difference between book and market values.
Usually, each bond manager has a separate wrap. IBM executives, however, decided to wrap all with a single contract, using a group of five providers to share risks on a proportional basis across the entire wrapped synthetic portfolio.
The synthetic contracts represent about 40% of the fund's assets. Traditional insurance company GICs make up another 40%, and immunized fixed-income investments, the remaining 20%.
Dan Libby, IBM investment manager, wouldn't name the five providers.
Mr. Libby said he expects the restructuring of the stable value portfolio to "make the management of this asset class more consistent with the investment processes employed for all other asset classes in both the defined benefit and defined contribution plans."
Under the new structure, IBM can switch bond managers or investment sectors without unwinding the wrap contract.
"IBM, as plan sponsor, will reserve the right to hire or fire managers and allocate assets for either strategic or tactical purposes without the prior involvement of the wrap providers," said Mr. Libby. "This is in much the same way that an investment manager trades in securities without the involvement of the wrapper provider in a traditional actively managed synthetic GIC."
He said the change would improve operating efficiencies and standardize reporting of investment return information from a diverse portfolio.
IBM is the first to implement a universal wrap. IBM's stable value fund has eight bond managers running the approximately $1.4 billion underlying the synthetic contract assets.
Mr. Libby described the modifications as a natural extension in the development of the synthetic stable value market.
"IBM's structure explicitly wraps the plan sponsor's portfolio of investment managers, and we coined the term global wrap for this structure," he said.
The stable value fund is one of seven investment options in IBM's $11 billion 401(k) plan. The others are measured against a benchmark. But, there has been no widely accepted market-based benchmark for stable value assets.
IBM now plans to use market value-based benchmarking as part of the fund's restructuring.
The custodian change also is important to the redesign of IBM's stable value management approach, Mr. Libby said.
A central issue in State Street Bank's selection was compliance oversight, he said. That's because the global wrap structure "targets tighter risk management procedures by means of checking compliance to a set of overall guidelines across the various investment portfolios. This will be systematically monitored by the custodian," Mr. Libby said.
"The custodian will act as a referee for issues such as month-end pricing, performance, billing and compliance in much the same way that IBM leverages its custodial relationship in its defined benefit plan," said Mr. Libby.
Mr. Libby also said the global wrap structure "does not require that the entire benefit responsive risk be underwritten by one provider, which would have been unacceptable to IBM."
Instead, he said, IBM used five wrapper providers who share the risk on a proportional basis "across the globally wrapped portion of the fund."
He said the global wrap "allows the plan sponsor to separate out the asset management and benefit responsive aspect and thereby to better align the interest of the plan sponsor, plan participants and the wrapper providers."
The wrapper provider, said Mr. Libby, "is most concerned with disaster risks such as credit quality, duration, demographics and even structure of the savings plan . . . while the plan sponsor is more concerned about investment performance risks."
"The wrapper component is an essential component of this asset class but should be viewed as a risk reduction tool," he said. "This structure allows for complete flexibility by separating the wrap function from the overall management function," he said.
"For example, within the globally wrapped portfolio, IBM has the flexibility to choose which portfolios would be required to make liquidity available for participants should that become necessary," he noted.
Another benefit is reduced administrative burdens on the fund.
"I expect that the wrapper contracts with each provider will be fairly standardized. And, going forward, the fact that we will remove a layer of contracts and administration really benefits all parties involved, including the participants," he said.
He said IBM expects a "significant reduction" in direct costs associated with managing its synthetic stable value contracts. He didn't elaborate.
"In my opinion, this arrangement represented a rare win-win scenario for both the providers and the client because it did provide a lower cost for the client as well as a lessened degree of risk for the (wrapper) providers. I appreciated the diligence and effort shown by the providers selected for their becoming comfortable with the perspective that IBM has for its ($66 billion) retirement fund, namely that of a fund-of-funds manager."