Stable Value:Higher Fees, Lower Returns
“There are changes going on in the stable value market, and they are not trivial,” says Rod Bare, a Chicago-based defined contribution consultant at Russell Investments. “But it is not a reason to panic.”
The wake of the 2008 market crash has found some stable value providers exiting the market, fees jumping and returns declining. The stakes remain high: Stable value funds account for $460 billion of the $3.2 trillion in defined contribution assets in BrightScope Inc.’s database, the financial-information company said in November 2011, when announcing its ranking of the top 20 stable value funds by total distribution in 401(k) plans. TIAA-CREF’s TIAA Traditional Annuity holds the largest share, followed by Fidelity Managed Income Portfolio, State Street Global Advisors’ SSgA Stable Value Fund, Vanguard Retirement Savings Trust and T. Rowe Price Stable Value Fund.
Where guaranteed investment contracts (GICs) and separate account GICs once dominated, synthetic GICs took over the stable value market for 401(k)s in the late 1990s, says Chris Tobe, principal at Louisville, Kentucky-based Stable Value Consultants. “Typically, the largest companies [$100 million in assets and more] exclusively use synthetics for their 401(k) stable value,” he says. Synthetics take underlying bonds and put a third-party wrap over the top that sets a guaranteed interest rate. With synthetic GICs, plan participants own the underlying bonds versus relying on a promise in a contract, substantially reducing the possibility of losses.
Bare offers another reason that plans gravitated toward synthetic GICs. “The appeal of the synthetic was that they were able to engineer portfolios that had higher yields,” he says. “The problem was that these were high-yield instruments that probably should not have been in there.”
After the financial crisis, some banks abandoned stable value wraps, and some stable value providers, such as State Street Global Advisors and Charles Schwab Bank, announced plans to exit the market, citing the difficulty of arranging wraps. “There are more profitable places to put bank capital to work,” Bare says of the wrap pullback. “Ten to 15 years ago, banks entered that market and competed wrap prices down, and the prices probably were competed down too far. So the return on investment is not there.”
Some insurance companies have stepped in to replace a portion of the synthetic GIC capacity, but the market remains tight. “Folks are pulling out, so this has created more negotiating power for the remaining wrap providers,” Bare says. And more of the remaining wrap providers now want their affiliates to do underlying bond management of the slice they wrap. “It makes a big difference, because this is coming at an incremental cost,” he says. “That is a subadviser charge being added.” Despite more subadvisers taking over part of management, stable value managers have not adjusted their own management fees as a result, he says. “Their point is, it takes a lot of work to put these together.”