Using stock-based funds as a default retirement plan investment vehicle may expose many affected plan participants to excessive risk.
Cynthia Mallett, a vice president in the institutional business at a unit of MetLife Inc., New York, made that argument Wednesday at a hearing organized by the ERISA Advisory Council, an arm of the Labor Department.
The council is looking into concerns about the stability of stable value funds during the current crisis, and demands that the U.S. Labor Department should permit retirement plans to use stable value funds as “qualified default investment alternatives” for participants who fail to take active steps to allocate their plan assets.
Mallett and James King Jr., a vice president in the stable value markets group at a unit of Prudential Financial Inc., Newark, N.J., spoke up for stable value funds.
A stable value fund is a fund that seeks to offer a relatively high fixed rate of return by investing in guaranteed investment contracts, bonds wrapped in insurance wrappers, and other products that have generally had a low risk of default.
Unlike a money market fund, which must invest with the interests of users who need immediate liquidity in mind, managers of a stable-value fund can reap higher returns by assuming that most retirement plan participants will be leaving assets in the plans for many years, Mallett said, according to the written version of her testimony.
In 2007, when the QDIA program was developed, the stock market was doing well. Some investment experts and others argued that the funds that 401(k) plan administrators use for QDIAs should offer variable returns linked at least partly to the performance of the stock market, to give plan participants a chance to share in stock market gains.
In many cases, Mallett said, the funds plans have used as QDIAs have exposed affected participants to a great deal of equity market risk. Some QDIA funds have invested all of their assets in stocks and other vehicles tied to the performance of the stock market, she said.
Mallett argued that the workers most likely to be subject to auto enrollment – short-term workers, lower-paid workers, and job-changers – are the workers most in need of the kind of preservation of capital that a stable value fund can offer over relatively short periods of time.
Employers may be reluctant to adopt a QDIA provision when they see how poorly the investment vehicles allowed as QDIAs served employees during the recent stock market slump, Mallett said,
Because the QDIA regulations discourage use of stable value funds as default investments, “the regulations effectively encouraged both sponsors and participants to select products that carried significantly more risk than actual experience suggests participants can either understand or manage,” Mallett said. “The market events of the past 2 years have helped to illustrate that taking additional risk in pursuit of higher investment returns may not be more prudent, as a public policy matter, than preserving capital as a means of building a base for retirement income security.”
King presented a similar argument.
Today, he said, “the collapse of the financial markets highlights the need for investment options that both protect and grow principal.”
Mallett cited research suggesting that stable value funds may have performed about as well as intermediate bond funds in recent years while exposing investors to a much lower level of volatility.
In the long run, she said, plan participants in QDIAs would be better off having more exposure to stock investments, but she noted that few plan participants with money in default investment options are in the same plans 3 years later.