The Federal Reserve Employee Benefits System is using an innovative form of bond laddering in its $5.5 billion defined contribution plan to replace the GIC-laden stable value option that had been its most popular with participants.
The change was necessary “to introduce new fixed-income options that offered certainty of returns but did not have the concentration of risks from investing in guaranteed investment contracts,” William Clark, chief investment officer of the Newark, N.J.-based Federal Reserve Office of Employee Benefits, said in an interview.
Investments in the stable value fund had been 100% in GICs until the fourth quarter of 2008, when plan officials began investing new participant contributions and maturing GICS into a prime money market fund they incorporated into the stable value option, known as the Interest Income Fund.
Mr. Clark said plan executives were concerned that there were GICs from only seven insurance companies in the Interest Income Fund, and only three of them were offering new contracts. “A secondary concern was that the plan restrictions imposed by the GIC issuers limited the plan's flexibility to introduce new investment options and change various plan provisions,” he said.
Plan officials began phasing out the internally managed stable value option in July. That option had been offered since 1970.
In its place, plan officials launched a series of three bond funds — the Select Maturity Bond Family — with maturity dates of June 30, 2014; June 30, 2016; and June 30, 2018. “This allows the participants to invest in the equivalent of a CD (certificate of deposit) ladder or a bond ladder,” said Mr. Clark, adding that most participants choosing this option have invested in all three maturities.
The new bond-fund family is managed by BlackRock Inc., New York, which also manages a bond index fund and a Treasury inflation-protected securities index fund for the Federal Reserve's plan. (The plan also offers a passive Government Securities Fund, managed by State Street Global Advisors.)
Each of the new BlackRock funds will invest in U.S. Treasuries, other U.S. government agencies, foreign governments, corporate debt and securitized-debt-backed by a loan, lease or mortgage.
The allocation to the five sources varies with the length of maturity of the funds within the bond family. “There are strict credit and diversification requirements in order to limit the potential for — and exposure to — defaults in the underlying portfolio,” Mr. Clark said.