PFM Asset Management LLC
P&I: What is PFM Asset Management's investment strategy and process for stable value?
David Starr: Our investment strategy starts with seeking a deep understanding of the client's objectives and an analysis of the plan and fund's cash flow and demographic profile. From there we are able to develop an appropriate duration target and build an asset allocation strategy that may consist of a combination of synthetic GICs, insurer separate accounts and traditional GICs according to investment policy and client objectives. We approach the underlying fixed-income strategy with a view toward gaining the correlation benefits of different strategy styles, all with an eye toward customization of the portfolio to meet each client's needs and objectives. We have found over time that a diversified and transparent approach to addressing a plan's unique risks has provided the basis for a competitive stable value outcome.
P&I: Have structural changes in the defined contribution market, such as the growth of target-date funds, affected stable value demographics?
David Starr: Most definitely. Because of both [target-date funds] and the elimination of stable value as a safe-harbor qualified default investment alternative (except in special circumstances), fewer new or younger participants invest in stable value. Because older participants generally have higher balances and invest more conservatively, the average age of a stable value participant has increased both on a straight and dollar-weighted basis. Moreover, retirees remaining in the plan, and there are many who do so because of access to stable value, control a substantial [portion], and in many cases majority, of the stable value assets in many plans. Therefore, required minimum distributions, lump-sum payments following death and the temptation of lump-sum transfers if money market and CD yields exceed stable value yields create the potential for significant cash flow and withdrawal activity, further reinforcing the need to focus on an appropriate duration and adequate liquidity.
P&I: What additional risks are stable value funds exposed to in this changing environment?
David Starr: Even without the additional layer of demographic and cash-flow risks, strategies that are exposed to increased duration [interest rate] risk are prone to being less responsive in a rising-rate environment. In particular, funds that are targeted to longer-duration benchmarks, such as the Bloomberg Barclays Intermediate or Aggregate indexes, are taking on the dual risks posed by duration drift and changing demographics. Additionally, larger-asset-base stable value funds or stable value strategies with potentially highly volatile cash flows structured within collective investment funds have the potential to adversely impact the returns of the other sponsor plans participating in the commingled structure. In our judgment, it is an appropriate time for plan sponsors to consider the benefits of a strategy customized to address the unique needs of their participant population. ■
The material contained herein is for informational purposes only. This content is not intended to provide financial, legal, regulatory or other professional advice. It is not an offer to purchase or sell securities. PFM Asset Management LLC is registered with the SEC under the Investment Advisers Act of 1940.