May 13, 2010

Retirement Plan Advisor, August 2009: Stable Value as QDIA Up for Debate Again

Supporters say stable value should be core asset class for retirement

The steady, dependable nature of stable value funds was not so attractive in booming markets, when the search for high yield dominated everything else. But now that the retirement finance dialogue has once again shifted to the need for Americans to put their money into secure investment vehicles, stable value funds are on the menu. James King, VP and head of Newark, New Jersey-based Prudential Retirement's Stable Value Markets Group, believes that stable value funds should even be classified as qualified default investment alternatives (QDIAs) in employee sponsored retirement plans.

"We really think that there is a need for stable value funds to be offered as QDIAs because there is a need for products that both protect and grow principal as these do," says King - who testified before the U.S. Department of Labor's (DOL) Employee Retirement Income Security Act (ERISA) Advisory Council in late July. "Stable value funds should be a core asset class for retirement because they are different from other QDIA options that have specific exposure to equities, which is appropriate for some but not for all."

The debate on stable value funds is only just beginning and it remains to be seen when and whether they will be included in the QDIA panoply. King will testify a second time before the ERISA Advisory Council in September and he is hoping that the recommendations ERISA will then make to the secretary of the DOL in November will include adding stable value to the QDIA menu.

According to King, stable value funds--which invest in high quality corporate and government bonds and are backed up by "wrapper" contracts provided by banks and insurance companies--provide sufficient returns over the long term similar to the kinds of returns delivered by intermediate bond funds and money market funds. In fact, research done by Wharton University professor David Babbel and Miguel Herce, principal at global consulting firm CRA International, has proven that over time, stable value funds actually offer even greater returns than the other two asset classes. From January 1998 to December 2008, Babbel and Herce's research showed that stable value funds returned 6.3% in net value, compared to 4.1% for money market funds and 5.7% for intermediate bond funds.

Furthermore, the 2008 annual return for the S&P 500 was -37%, while stable value funds returned 4.68%, according to the Stable Value Investment Association's (SVIA) 13th Annual Stable Value Investment and Policy Survey.

The SVIA also says that over $642 billion is currently invested in stable value funds--a significant figure, says Kansas City, Missouri-based Eric Jacobson, a fixed income investment specialist with Morningstar, Inc. With the focus remaining on investment safety and protection of principal, stable value funds are likely to become even more attractive to retirement savers, Jacobson says.

However, in order for stable value funds to qualify as QDIAs, Jacobson believes that there is still a long way to go. "There is definitely a lot more openness to these funds and there is potential for stable value to become a QDIA, but there are still a number of issues that one must keep in mind about what kind of products stable value funds really are before getting to that point," he says.

For one, there has been some weakness in the portfolios underlying certain stable value funds. Jacobson says "word is that some managers invested in high yield bonds and currency risk, so one can only assume that some subset also had exposure to subprime mortgages." Plus, because stable value funds are not offered as mutual funds, they have no public disclosure, so it is impossible to tell what really constitutes them, he says. But the bigger problem is simply the complexity of these vehicles, Jacobson says, in particular the insurance wrapper with which they come.

"No one really understands how these things actually work and what really is complicating things now is that the insurance wrappers stable value funds depend on are much less available because of the crisis," he says. "AIG was one of the major providers in the industry, and if one insurance company - the one that was the biggest in the world--can go under, what is to stop that from happening to any of the others? This is not the soundest way to manage your retirement account then."

Of course, there are still a number of insurance companies with wrapper contracts they will look to honor and a number of providers in the market, Jacobson says, but if an asset manager gets new money to put into stable value funds, getting new wrapper contracts is going to be tough.

There is no denying that stable value funds are complicated in their structure, King agrees, and with certain insurance companies and banks having gone under, there is a lot more pressure on the global wrap market. However, other companies like Prudential are dedicated to the stable value space, so "institutional plans looking to add stable value partners should be looking for stable value funds with the capital adequate to back up their guarantee," he says. "We at Prudential use a full faith and credit guarantee."

In his July testimony, King also spoke about the need for plan sponsors and investment consultants to access information to evaluate the benefits and risks of stable value products given their unique combination of an insurance guarantee and a fixed income portfolio. "During the fourth quarter of 2008, Prudential adopted practices that significantly increased the transparency of our general account stable value products' investment strategy and portfolio holdings," he testified.
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