The recent drop in financial markets has rekindled the demand for safer, conservative financial products like stable-value funds.
While stability often comes at a greater price-higher fees and historically lower returns than stocks and bonds-the peace of mind these products provide can be worth the cost to many investors.
"Participants must have an investment option that enables them to have retirement security," said James King, vice president and head of the stable value markets group at Prudential Retirement.
King said the collapse of the financial markets and continued volatility highlights the need for investment options that protect and grow principal, for young investors in defined contribution plans as well as those nearing retirement.
"Stable-value products, with their relatively high returns, low volatility and protection features such as capital reserves to back guarantees, provide a compelling solution," King said. "As such, it is essential that stable-value products be classified as a qualified default investment option."
Stable-value providers ardently lobbied for their products to be considered as a default option under the Pension Protection Act of 2006, but ultimately they were unsuccessful. Nevertheless, approximately half of all 401(k) plans currently offer stable-value options to their participants.
Predictable
"DC plan sponsors should provide their participants with the safest investment option possible," said Christine Marcks, president of Prudential Retirement. "A 'safe' investment option should protect a participant's principal investment, provide a predictable stream of returns and generate sufficient returns such that growth in the participant's principal investment will at least keep pace with inflation."
Stable-value products currently represent about $520 billion in retirement plan assets, Prudential said. At the end of 2007, stable-value products represented 19% of the assets of the 1,000 largest public DC plans, and 13% of the assets in the 1,000 largest corporate DC plans. Stable-value products earned an average rate of return of 4% in 2008, while virtually every other asset class experienced double digit declines.
Regulators are opposed to making stable-value products a default option for the simple fact that a large number of participants do not change out of whatever option they are defaulted into.
Most retirement experts agree that stable-value products can be a part of a diversified portfolio, but several major studies have stressed that most investors need to be saving substantially more for retirement. Extremely conservative investment options like stable-value funds barely keep up with inflation and won't be enough to help investors build the nest egg they need.
But Marcks said many investors simply have a lower risk tolerance and are willing to give up potentially higher returns in exchange for more peace of mind. Some investors, such as those near retirement, have a very short-term investment horizon and can't afford to expose their life savings to too much risk.
She said stable-value products can offer investors higher levels of protection than money market funds and investment grade intermediate-term bond funds, as well as more predictable returns and similar or higher expected returns.
"Money market funds and intermediate-term bond funds do not provide explicit guarantees that an investor's principal will be returned," she said. Most money market funds attempt to maintain a stable net asset value that prevents capital losses, but they do not explicitly guarantee a level NAV and are not required to reserve capital to protect a level NAV, she said.
Stable-value funds are able to deliver higher returns and lower volatility because they combine an investment, usually in intermediate-term fixed income securities, with an insurance contract that guarantees the return of the investor's principal and accumulated interest earnings, King said.
Also, stable-value funds and intermediate-term bond funds typically deliver higher long-term returns than money market funds because the duration of their underlying securities is two to four years, compared to less than a year for money market funds.
Drawbacks
"While stable-value investments may appear to some as 'risk free,' they clearly are not," said Kent Peterson, director of investment services and senior associate actuary for Minnesota-based Securian Retirement.
"When financial markets are under significant stress, it is likely that a stable-value investment option is as well," he said.
Especially in light of the problems money market funds were found to have last year, the transparency of stable investments is a subject of concern for fiduciaries.
While most investment options are marked to market on a daily basis, this is not the case with stable-value investments, which are designed to preserve capital while providing steady, positive returns, Peterson said.
Hidden Risk
"Because steady returns may imply little or no risk, it is imperative that plan fiduciaries thoroughly understand stable-value investments," he said. "In some ways, they have a higher degree of responsibility with these investments because the risks are not as obvious to participants."
There are three types of stable value investments-general accounts, separate accounts and guaranteed wraps-and each offers its own unique issues.
"While stable-value investments have operated in a very 'friendly' economic environment of generally declining interest rates, adverse economic conditions could cause issues such as significant increases in the cost of these guarantees, a decrease in interested wrap providers and a significant decline in wrap provider capacity," Peterson said.
He said fee transparency is an issue in the stable-value universe, but the industry will need help making sure all participants share costs equally, as well as finding a way to disclose the myriad of fees without confusing investors.
"Plan fiduciaries should not allow themselves to be lulled into complacency," Peterson said. "The historical stability of returns of stable-value investments obscures their inner workings. While the risks may be appropriately managed, the plan fiduciary cannot presume this to be the case. A plan fiduciary must apply a prudent process that observes the facts and circumstances. Otherwise, the interests of plan participants may not be adequately protected."
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