Stable value funds have come under fire from consultants — whose interest in recommending the investment to clients is waning — and from a Government Accountability Office report that expressed concern about liquidity, risk and disclosure.
But throwing stable value funds overboard as an investment option is unwise. In times of such market volatility and uncertainty about the credit risk of corporate fixed-income securities, and even the risk-free status of Treasury securities, defined contribution plan participants might find the stable value investment option more attractive than ever.
Stable value is designed as a high-quality low-risk, low-volatility fixed-income investment option to preserve participant assets, while providing steady positive returns. The stable value funds are generally supported by wrap contracts provided by third parties that insure the protection of principal.
However, a survey of defined contribution consultants, and the GAO study, each separately raised concern about withdrawal restrictions imposed on employers and participants, among other issues.
Top issues consultants cited in the survey were restrictive agreements imposed by stable value wrap providers and lack of wrap capacity and wrap fees. They also recommended plan executives evaluate underlying investments. The GAO study also raised concerns about withdrawal restrictions.
Such concerns about stable value investments deserve attention, but they can be addressed by ensuring disclosure of the underlying investments and risks, removing any withdrawal limitations and ending any preclusion of other investment options.
To keep and build clients, the stable value industry has to address the concerns, in part through greater transparency.
There must be more disclosure of the structure of these vehicles — including descriptions of the underlying investments, identities of the providers of the wrap guarantees, and the details of such guarantees — so plan executives and participants can evaluate the stability and security of a stable value fund and the counterparty risk of the provider of the wrap.
Limitations on transparency and communications imposed by stable value funds, as related in the GAO study, are troubling to plan executives and might hamper the performance of their fiduciary duties.
The Department of Labor, in response to the GAO study, noted “current regulation specifically requires ... information pertaining to investment risks, as well as investment strategies, be available to plan participants.”
But the GAO study noted “wrap contracts typically prohibit sponsors from making any communication that may result in fund redemptions.” When plan executives becomes aware that a stable value fund's underlying assets have “fallen below book value, which could put participant assets at risk,” their communication to participants could void the insurance contract. But “failing to communicate this information to participants may compromise the plan sponsor's role as a fiduciary.”
The DOL should review its own regulation, and the GAO findings, to resolve any discrepancy so as to ensure plan sponsors can and do fulfill their fiduciary duties. Plan executives, in turn, should not accept contracts they do not understand, nor those with structures that lack full transparency and cannot be explained to participants.
Investors are hungry for investment stability after the financial market crisis and continuing volatile swings in the markets. These concerns are compounded by a protracted weak economy, as well as federal fiscal challenges — including the looming issue of a huge federal deficit and the fight over the raising of the U.S. federal debt ceiling and potential of a federal default on Treasury securities.
A traditional flight to refuge in the safety of risk-free Treasury securities now comes with a potential nightmarish scenario of a U.S. default and lower credit ratings.
“Investors, including 401(k) plan participants, experienced large losses from their investments in 2008,” according to the GAO report, issued in March. It noted reports that some 401(k) participants as well as plan sponsors were restricted from withdrawing plan assets in certain situations.
David L. Wray, president of the Profit-Sharing/401(k) Council of America, said “the stable value system probably was the best-performing asset program in the country” during the credit crisis.
Transparency is crucial. Because participants in defined contribution plans bear all the risks, sponsors must ensure they meet their fiduciary responsibilities. And providers of investment vehicles must support them in the responsibility by providing the information they need to do so. Further, any limitations on withdrawals, or communications between sponsor and participant, must be removed.