Retirement Insights

Stabilize Your Plan’s Stable Value Selection Process

Stabilize Your Plan’s Stable Value Selection Process

As investment markets become increasingly unsettled and interest rates increase, participation in stable value investment products is growing, especially among older retirement plan participants who are looking for fixed-income capabilities. Therefore, we believe it may be a good time for a frank discussion about stable value products and how retirement plan committee members select and monitor such options for their plan investment menus.

Background

Most defined contribution plans include some type of stable value product1. In general, their key features of

  • Principal preservation,
  • Historically consistent, positive returns and
  • Liquidity for participant benefit payments

make them a popular plan menu item. Of late, they have become plan participants’ vehicle of choice for capital preservation in 401(k) plans. Stable value funds took in 82 percent of 401(k) trading inflows in June 20222. (Outflows were from target date, large U.S. equity and international equity funds.)

A stable value fund is a bond portfolio that is “wrapped” with a guarantee so that changes in the market value of the underlying bonds are offset by a short-term credit facility. This enables investors to withdraw money at par value, thereby having the potential to insulate plan participants from day-to-day market volatility. Because of their use in a retirement plan environment, they are valued using a contract value accounting method approved by the Financial Accounting Standard Board (FASB) rather than the mark-to-market accounting required for most other investments. This accounting standard allows stable value products to potentially steady the returns earned by plan participants and hopefully insulate them from daily market volatility. As a result, stable value products tend to be less volatile than other asset classes.

Like any other investment product, however, there are inherent risks to stable value products. For example, if the market value of a stable value product is significantly below its book value, a stable value product may be unable to meet benefit obligations. Another risk factor is an inflationary cycle and a rising interest rate environment. Over the short term, the rates paid by stable value products tend to lag behind other rate-sensitive products. Over the long term, as a result of the longer duration of the bonds held in the underlying portfolio, stable value products in general have been able to pay higher rates than money market funds since their development in the late-1970’s.

However, since the stable value market has never experienced an extended period of time where interest rates continued to rise, as occurred from 1955 through 1981, we believe it is justifiably worthy for fiduciaries to consider that potential risk and the impact that may have on their retirement plan participant accounts.

Choosing Wisely

Picking an appropriate stable value option for a retirement plan is tricky. And, unfortunately, plan officials often approach stable value fund assessment with faulty assumptions due the lack of clear understanding of what a stable value fund is. Moreover, few plan committees have an appreciation for the subtle nuances and differences between stable value product types (there is more than one).

Consider, for example, the typical plan investment vetting process a plan committee uses when considering several large cap value funds for the plan. Likely, the committee will look at returns, manager tenure, costs and, perhaps, alpha and beta. The presumption is large cap value funds are homogeneous in many respects.

Taking the same assessment approach with stable value products, however, may be deleterious because stable value funds are more heterogenous than many other investment options. It is not easy to effectively evaluate and monitor stable value funds because they have several characteristics and variables that are not a part of other asset classes. Additionally, there are considerable differences among stable value products.

Understanding the unique aspects of stable value funds is the first step of an effective evaluation and assessment strategy that, when documented, can help plan committees satisfy the fiduciary standards under the Employee Retirement Income Security Act (ERISA) of 1974 to which committee members are held. Committee product education is important, plus guidance and/or advice from a financial professional can further ensure the committee establishes and follows a prudent selection and monitoring process.

In addition to the standard questions regarding returns, manager tenure and philosophy, and fees, some experts recommend including the following questions in a stable value evaluation and assessment process.

1. How is the stable value fund backed up or guaranteed?

Different products are backed up or guaranteed in different ways. For example, insurance company stable value products, commonly called guaranteed investment contracts or GICs, are backed by the financial strength of the insurance carrier. If the carrier became insolvent, potentially, there would be no assets available to pay participants. Bank or trust company stable value products, commonly structured as collective investment trusts (CITs), are often referred to as synthetic GICs. This means the offering organization contracts with one or more outside entities to insure all or a portion of the stable value product for a fee (commonly called a “wrap fee.”)

2. What is the financial strength of the organization(s) backing the product?

Ratings and creditworthiness are good proxies to understand the backer’s ability to follow through on the ability to back stop the product.

3. What are the stable value product’s underlying investments and credit quality?

Some products are a pool of specific investments, while others have no specific investments and are backed by the faith and credit of the issuing organization. For example, generally, insurance carriers do not have an earmarked portfolio of assets for their stable value products. Instead, the stable value product is, in effect, invested in and backed by the insurance company itself. This approach is commonly referred to as being back by the insurance carrier’s general account. Other stable value products, such as those issued by banks or trust companies have a specific underlying bond portfolio.

4. What is the stable value product’s market value ratio?

The stable value provider has an obligation to disclose the most recent market value ratio to fiduciaries. Products with higher market value ratios, preferrable above 100%, provide a greater margin of error if interest rates rise. Products with lower market value ratios usually provide less downside mitigation in a rising interest rate environment. This is an important characteristic when considering whether the portfolio and the wrap provider will be able to indefinitely withstand major increases in interest rates.

5. Is there a guaranteed crediting rate?

Some stable value products, specifically those offered by insurance carriers, usually offer a guaranteed rate of return. Non-insurance carrier products typically do not have a guaranteed rate of return.

6. Does the product have transfer and/or withdrawal restrictions?

Some products have limitations on distributions and transfers. These provisions, known as a put option, are complex and require close analysis by the plan officials before decisions are made regarding the stable value product selections. Some products allow immediate distributions for participant who have separated from services, while others do not. Other products impose a market value adjustment only if the book-to-market value ratio is below a certain percentage.

7. Is the product portable? Which platforms support the product?

Some stable value products are portable and can be supported by different recordkeepers while others are proprietary and limited to a single platform.

8. Do market value adjustments apply? If so, how are they calculated? Are there exceptions such as a put option?

Be aware that some stable value products are subject to market value adjustment rules. Market value adjustments may come into play when the plan sponsor initiates a liquidation of the fund, and the market value of the underlying pool of investments in the fund is less than the book value of the investments.

Consider the following example.

Stable Value Fund X

Book Value = $10,000,000

Market Value = $8,000,000

Because the Market Value is less than the Book Value, Stable Value Fund X is subject to a market value adjustment if an immediate liquidation is requested

A “put option” is one way to mitigate a market value adjustment in this scenario. It is a provision that allows a plan to leave a stable value fund at book value after satisfying a waiting or notice period (generally, 12 months).

Put options and their limitations can be complex and require close analysis by plan officials before decisions are made regarding a stable value product selection. Some products impose a market value adjustment only if the book-to-market value ratio is below a certain percentage. Plan officials must read the fine print carefully.

9. What information is the committee using to evaluate a stable value fund?

Another consideration for committees is ensuring they review information from multiple, reliable, and independent sources. Recently, a consultant at the Retirement Learning Center observed a plan committee had evaluated and selected a stable value product based solely on the marketing information provided by the product provider. No other products were considered, and no independent information was solicited.

Considering the strictness of the “prudent expert” standard of ERISA, the DOL would be unlikely to conclude such a selection process was in the best interests of plan participants.

Conclusion

Stable value products are popular and useful investment choices for defined contribution retirement plans. Yet, they are not created equally, which makes it difficult for plan committees to settle on a product that is a good fit for a retirement plan investment lineup. The need for a prudent documented assessment process that includes education, plus investment guidance is essential to mitigating fiduciary liability with respect the committee’s selection and monitoring duties. Plan officials and investment committee members are encouraged to explore the significant differences in how the funds are structured, backed, credited and the possible limitations on distributions.

This material is for informational purposes only and is not to be construed as specific tax, legal, or investment advice. You are strongly encouraged to consult with your independent financial professional, lawyer, accountant or other advisors as to investment, legal, tax and related matters.

The opinions expressed are not necessarily those of the firm. These materials are provided for informational purpose only. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice. Any statistic contained herein have been obtained from sources believed to be reliable, but the accuracy of this information cannot be guaranteed. The views expressed herein may change at any time subsequent to the date of issue hereof. The information provided is not to be construed as a recommendation or an offer to buy or sell or the solicitation of an offer to buy or sell any fund or security.

Risk Disclosures:

A stable value investment is not insured or guaranteed by the U.S. government. There is no guarantee that an investment will be able to maintain a stable net asset value.

All investments involve the risk of loss of principal.

A stable value fund is a bond portfolio that is insured against a decline in yield or loss of capital.

A bull market is the condition of a financial market in which prices are rising or are expected to rise.

Alpha is the excess return of an investment relative to the return of a benchmark index.

Beta is a measure of a stock's volatility in relation to the overall market.

FEF Distributors, LLC (Member SIPC) distributes certain First Eagle products; it does not provide services to investors. As such, when FEF Distributors, LLC presents a strategy or product to an investor, FEF Distributors, LLC does not determine whether the investment is in the best interests of, or is suitable for, the investor. Investors should exercise their own judgment and/or consult with a financial professional prior to investing in any First Eagle strategy or product. First Eagle Investments is the brand name for First Eagle Investment Management, LLC and its subsidiary investment advisers.

First Eagle Investments is the brand name for First Eagle Investment Management, LLC and its subsidiary investment advisers.

©2022 First Eagle Investment Management, LLC. All rights reserved.

1Plan Sponsor Council of America, 64th Annual Survey, 2021

2Alight Solutions 401(k) Index, June 30, 2022.

3Governing; Stable-Value Funds: Their Time Under Heaven, April 2021