Stable value will go under the microscope

The Department of Labor's ERISA Advisory Council is studying whether more regulation is needed for stable value funds, a core DC investment option that has been shaken by recent market turmoil.

The council, which will examine stable value funds on the second day of its July 21-23 meeting, will recommend whether the DOL's Employee Benefits Security Administration should provide additional requirements or guidelines for the design and marketing of stable value funds to plan sponsors and retirement services providers.

In addition, the council will recommend whether additional guidance is needed to help plan sponsors and their consultants choose, value and monitor stable value funds.

Trisha Brambley, a member of the council and president of RESOURCES for Retirement in Newtown, Pa., said this scrutiny of stable value funds is largely driven by the increasing number of plan participants moving into such funds, often from target-date funds. “We also need to ask what's in these funds and can they achieve their stated objectives,” she said. “In the past, I think plan sponsors just selected these options based on returns.”

The 15-member group also will look into whether the current disclosures to participants about stable value funds are sufficient, and investigate whether it would be appropriate to include stable value as a qualified default investment alternative in 401(k) plans. The council plans to report its findings to the Department of Labor in October, said Stephen McCaffrey, a member of the council and senior counsel, National Grid USA, New York, which has a $2.9 billion DC plan.

“Like most fiduciaries, we're closely monitoring our stable value investments, as well as other investments in our portfolio — given the current market environment,” Mr. McCaffrey said. He said the discussion will be similar to what was addressed in last month's joint Securities and Exchange Commission and Department of Labor hearing on target-date funds.

Gina Mitchell, president of the Stable Value Investment Association, Washington, said she believed the hearings will lack the controversy of the target-date debate. “Given these unprecedented times, everyone is trying to do their due diligence, and I think it's an opportunity for stable value funds to tell their story,” she said. “This asset class has held up remarkably well, providing principal protection and a steady return.”

Stable value has gone in and out of favor with defined contribution plans. The investment option accounted for 16.9% of the top 200 DC plans' average portfolio for the year ended Sept. 30, 2002, according to Pensions & Investments data. That percentage dropped to 12.6% in 2007, as many participants took on more investment risk and diversified into equities. Last year, however, stable value accounted for 29.4% of DC plans' average portfolio, as investors sought safety in turbulent markets.

According to Ms. Mitchell, individuals had about $642 billion in stable value funds through 167,000 defined contribution plans as of year-end 2008.

The funds invest in a bond portfolio protected from wild swings in interest rates through contracts, or wraps, provided by insurers or banks. These wraps guarantee participants will receive the fund's book value even if the market value falls.

While experts say stable value remains a relatively safe investment option for 401(k) participants, they point to causes for concern.

For starters, the market value of the underlying securities has been falling in many funds, leading to lower returns for participants and upping the pressure on wrap providers to make up the difference. As a result, many wrap providers are limiting new business or are looking to exit the business altogether to contain costs, said Philip Seuss, a Chicago-based principal at Mercer.

The typical wrap fee also has ballooned to as much as 20 basis points, from just six to eight basis points a year ago, he said.

Plan sponsors have reacted to these changes by more closely monitoring their investments. “Investing in stable value used to be like watching paint dry,” said William Atwood, executive director of Illinois State Board of Investment. The board's $2.6 billion defined contribution plan had 27.5% in stable value as of Sept. 30.

“The problem is guys like me remember when these were GIC (guaranteed investment contract) funds. But now they're increasingly relying on asset-based securities and even more exotic securities. You really need to be on top of what's in your portfolio,” Mr. Atwood said.

Don Perrine, director of investment management at First Energy Corp., Akron, Ohio, agreed. “We're doing a lot more monitoring, but we believe we've got our processes right,” Mr. Perrine said. “We just keep our fingers crossed that the markets get better.” First Energy's $1.9 billion 401(k) plan had 23.5% of its assets in stable value as of Sept. 30.

Robin Pellish, a consultant at Rocaton Investment Advisors LLC, Norwalk, Conn., said many plan sponsors are keeping in closer contact with their stable value providers, and staying aware of market vs. book value, and the performance of the underlying securities.

“Plan sponsors need to have regular discussions with their asset managers,” Ms. Pellish said. “These are still very attractive investments, but they use strategies that look straightforward, but are in fact complex.”

Sue Walton, senior investment consultant at Watson Wyatt Worldwide in Chicago, said fiduciaries also need to review their wrap structure.

For example, she said plan sponsors should understand how the collapse of a wrap provider would affect the fund. Many wrap structures have contingency provisions whereby the remaining wrap issuers in the structure increase their coverage for a short period to protect the fund. Finding a replacement, however, could be difficult, particularly for funds with wide gaps between their market and book value.

“Sponsors need to take the lid off these things, and see what terms have been negotiated with the wrap issuers,” Ms. Walton said.

Indeed, Illinois' Mr. Atwood, said he believed any increased regulation of stable value funds should involve requiring plan sponsors to disclose precisely the steps taken in choosing and monitoring their stable value product. “Plan sponsors need to do more than meet a marketing guy.”

Other plan sponsors are adding protection by moving from general account to separate account stable value products, said Gino Reina, vice president and consultant at Segal Advisors Inc., New York. Separate accounts are safer and more transparent than general accounts because they aren't impacted by the cash flows of other plans.

Separate accounts also allow the plan sponsor to have more influence over such decisions as investment guidelines and choosing the wrap provider, he said. The downside: A separate account typically has higher expenses for the investor, especially if it is a smaller account, Mr. Reina said.