Schwab's exit aside, stable value rides wave of rising fees

Charles Schwab Corp. became the latest provider of a stable value product to exit the business, but the difficulties in securing wrap guarantees the company cited in announcing it would liquidate its $7.6 billion fund aren't being felt across the board.

Instead, industry watchers say a reversal of the wholesale retreat of banks and insurers from guaranteeing 401(k) participants against losses in these fixed-income-heavy capital preservation strategies is well under way.

The rising fees that providers have been able to command for wrap coverage over the past few years are driving that rebound.

Wrap providers found the risks they were facing in 2008 disproportionate to the six- to eight-basis-point fees charged then. But those fees are closer to 20 basis points today, which makes stable value a more attractive business proposition, noted Matthew Gleason, executive vice president with Burlington, Vt.-based Dwight Asset Management Co. LLC and head of the firm's $36 billion stable value business.

That's especially so with insurers increasingly offering “bundled” wrap coverage, with the condition that some or all of the guaranteed stable value assets be managed by the wrap provider's affiliates, effectively adding another 20 to 30 basis points of return for the business, Mr. Gleason said.

Against that backdrop, the financial crisis-inspired rush for the exits has stopped, and “people are trying to get into the business” of offering wrap coverage again, noted Christopher Tobe, principal with Louisville, Ky.-based Stable Value Consultants.

Still, the rebound in wrap availability doesn't imply a return to the stable value industry's pre-crisis salad days, when securing guarantees was cheap and easy, industry veterans say.

The hurdles insurers insist plan sponsors clear to garner wrap coverage remain much higher than before 2008, and commingled products in particular — like the Schwab Stable Value Fund — are facing greater difficulties securing a piece of that expanding pie than are big plan sponsors using separate account vehicles, those veterans say.

Stable value is “all about marrying the investment portfolio with the wrap,” and insurers underwriting that wrap want to look through to a retirement plan's participants to better weigh the risks they're taking on, noted Matt Toms, an Atlanta-based senior vice president and head of U.S. public fixed income with ING Investment Management. It's easier for an insurer to look at the demographics of a separate account than at those of a commingled fund that could be covering hundreds or thousands of smaller plan sponsors, he said.

Another issue: Rules that allow smaller plan sponsors to exercise a 12-month put, which — in a scenario such as the one seen in 2008 — would allow the sponsor to cash out its participants' stable value investments dollar for dollar, when the portfolio's actual value was underwater, and park the funds in a new collective trust.

An executive with a large stable value manager who declined to be named said separate accounts probably account for two-thirds of stable value investments, with the remaining third in commingled vehicles. It's the latter that are being shut down, he said, citing Schwab and DB Advisors' Pyramid Stable Value Portfolio as recent examples. DB Advisors, New York, announced to clients in March that the $1 billion Pyramid commingled fund would be closed.

Dwight's Mr. Gleason said it wouldn't surprise him if smaller players in the industry are finding the post-crisis wrap environment more of a challenge. Negotiating and finding wrap capacity, negotiating contract terms and dealing with a growing number of investment restrictions increasingly requires a daunting level of complexity and deep legal expertise, he said.

What was seen in pre-crisis days as a low-fee, low-maintenance product has become high maintenance, agreed Mr. Tobe.

Market watchers say that complexity may well have contributed to the decision by Schwab to exit. Schwab had farmed out the management of the underlying assets to 11 managers, including Dwight, Neuberger Berman Group LLC and Standish Mellon Asset Management Co. LLC. Nine different insurance companies and banks provided wrap coverage.

The lineup of stable value providers has been so steady over the years that any exit “raises an eyebrow,” but Schwab's decision is probably more a reflection of that firm's unique strategic situation than a harbinger for the industry, said Gina Mitchell, president of the Washington-based Stable Value Investment Association.

Schwab's move might simply reflect that company's focus on distribution rather than manufacturing, Mr. Tobe said, noting that stable value heavyweights such as Galliard Capital Management and Invesco are doing just fine this year.

The business is picking up in “no uncertain terms,” and Galliard has been putting contracts on with new wrap providers, noted Karl Tourville, managing partner with the Minneapolis-based firm.

Industry watchers say the recent prolonged spike in market volatility and the near-zero returns being offered by money market funds — stable value's nearest competitor for the affections of capital preservation-seeking 401(k) participants — has added momentum to flows into stable value products this year.

The industry is “going gangbusters,” Ms. Mitchell said.

One barometer cited — the 1.5 million 401(k) plan participants with nearly $120 billion in combined assets at large U.S. companies tracked by Aon Hewitt — reflects that trend. In October, the Aon Hewitt 401(k) index showed 71%, or $307 million, of the money transferred by participants from one strategy to another during the month went into stable value funds, on pace with the previous quarter's $1 billion of inflows.

In that sense, continued talk about difficulties in securing wrap coverage could reflect the industry's rebound, as opposed to the disarray of three years before.

The sharp pullback by wrap providers since 2008 is reversing but with volatility stoking investor interest now, demand is coming back faster than supply, noted ING's Mr. Toms.

If that leaves smaller plan sponsors in a sticky wicket, bigger plan sponsors remain better positioned, even if securing wrap capacity has grown more complicated for them, market veterans say.

Executives at some large defined contribution plans say the stable value remains a cornerstone of their 401(k) plans.

Robin L. Diamonte, chief investment officer and director of pension investment for Hartford, Conn.-based United Technologies Corp.'s $37 billion in retirement assets, said: “Even with recent industry pressures around capacity and fees, the UTC Income (Stable Value) Fund remains a valuable and viable investment option within the UTC Savings Plan. Stable value funds offer participants a unique combination of par-value liquidity, principal protection and competitive yields.

“We remain dedicated to the investment option in our plan.”

UTC's stable value fund accounted for more than $7 billion of 401(k) participants' assets as of June 2011, roughly 45% of total defined contribution assets.