Winter 2009

Stable Value Fund Selection and Monitoring

 Written by Julie Klassen, ChFC, REBC, Regional Director, Market Development and Kent Morris, CFP, Vice President, Great-West Retirement Services 

Exercising due diligence for your Plan is very important in the best of times and absolutely critical now in what experts and pundits alike say is the most challenging economic climate since the Great Depression. The stock market is highly stressed, many high profile companies are merging, failing or being taken over and the credit markets are under extreme duress. As a Plan Sponsor, careful selection and monitoring of Plan investment options is always a fiduciary duty. With this in mind, we seek to share in this article some of our observations about Stable Value Fund (SVF) selection and monitoring as well as best practices in the industry. 

To paraphrase a familiar truism: There are things that we know we know; and there are things we know we do not know; and then there are things that we don’t know that we do not know. As a Plan fiduciary can you positively respond to the following questions?
  • An Investment Policy Statement (IPS) has been adopted for our Plan?
  • Our Plan Advisory Committee (or Board) adheres to the investment policies as set forth by our Investment Policy?
  • The IPS for our Plan provides for the selection and monitoring of a SVF and establishes SVF Investment Guidelines?
  • A SVF portfolio holdings report is provided to our Committee (or in the case of a General Account product Company ratings and credit quality of the Company’s General Account assets is known and monitored by our Committee)?
  • Our Committee is advised of our SVF portfolio Market Value to Book Value (MV/BV) ratio on a regular basis? 
  • Is our MV/BV at or above historical norms?
  • Our Committee seeks expert advice or counsel from qualified professionals, such as Plan Counsel, Independent Consultants, SVF managers and/or our Third Party Administrator (TPA) with respect to SVF selection and monitoring?
Stable Value Fund Selection
 
Before deciding on what SVF is best for your Plan it is important to compare the various types of SVF vehicles. The summary matrix below provides a high level overview of the three basic types of SVFs: Separate Account, Pooled Fund and General Account Products.

Product Feature
Separate Account
Pooled Fund
General Account
Investment Guidelines Set by Plan
Yes
No
No
Minimum Investment
Yes
No
No
Fee Transparency
Yes
Yes
No
Rate Crediting Method*
Typically, forward rate setting quarterly or unitized
Unitized
Typically, forward rate setting quarterly
Floor Rate Guarantee
0%
 (a floor rate can be offered via a general account contractual provision)
No
May be offered
Subject to Actions of other Plan Sponsors and its Participants
No
Yes
Yes
Termination Provision
Typically, in cash or “in kind”
(book value scheduled payments are sometimes offered with a portfolio restructuring plan and prior notice)
Book value up to 12 months notice of plan sponsor termination
Payments typically available in installments or immediately with a Market Value Adjustment (MVA) or at book value with up to 12 months notice of plan sponsor discontinuance
Ability to “self-amortize” MVAs
Yes
No
Yes, via a rate adjustment
Subject to Claims of Company Creditors?
No
No
Yes

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
*If a crediting rate is higher than what the underlying portfolio yield supports it will causes deterioration to the MV/BV.
 
Based upon the above SVF features, it is important to prioritize what is most important for your Plan. SVF Investment Objectives are briefly described below:
 
SVF Investment Objectives
 
Typically, SVF investment objectives are to:
 
1.                  Earn a high level of return relative to the other objectives of the fund.
2.                  Provide sufficient liquidity to pay plan benefits.
3.                  Provide stable and predictable returns.
4.                  Preservation of principal.
 
What are the basic components of a SVF?
 
 A glossary of SVF components or terms is below: 
  • Book value -amortized cost of the securities owned by a SVF fund, plus cash, plus accrued interest less the investment management fee.
  • Cash Buffer – cash allocation in a SVF. 
  • Duration and Average Maturity – a time measure of a bond’s interest rate sensitivity, based on the weighted average of the time periods over which a bond’s cash flows accrue to the bondholder. Time periods are weighted by multiplying by the present value of its cash flow divided by the bond’s price. A bond’s duration will typically be shorter than its maturity, with the exception of zero coupon bonds as maturity and duration are equal.
  • Equity Wash– may be applicable when there are competing fixed options, i.e., SVF monies are “washed” in an equity fund or a bond fund with an average maturity of three years or more for 90 days, typically, before participants may direct SVF monies to a competing fixed option.     
  • Fund Custodian - company holding the assets, may establish the share price or valuation.
  • Fund Manager - investment manager can be an individual (supported by portfolio analysts) or a team management structure.
  • GICs – Guaranteed Investment Contracts (traditional GICS); also Synthetic GICS which are wrap contracts issued by banks and insurance companies; allow for book value withdrawals for qualifying participant activity.
  • Management Expense – fee to manage the fund; is transparent with a separate account or pooled fund.
  • Market Value - closing market price for each security in a SVF.
  • Market Value Adjustment (MVA) – an interest rate adjustment formula that can cause actual crediting rates to increase or decrease in response to market conditions (a provision generally found in general account products).
  • “Put” Option – Typically, a 12 month notification provision is utilized in pooled or commingled stable value fund products to protect the remaining investors in the fund as well as the wrap issuer(s). A put provision seeks to benefit from any positive impact of withdrawals and to minimize any negative impact. Any gains from the sale of the underlying bonds in a falling rate environment remain in the fund.   Conversely, any losses from the sale of underlying bonds in a rising rate environment, i.e., when interest rates rise above the yield on the fund and the market value of the underlying bonds fall below the book value of the fund, the remaining investors absorb the loss to the fund via a slight reduction in the fund’s yield.   As such, the pooled funds require 12 months notice that the plan wants to withdraw from the fund. The fund then has up to 12 months to pay out the funds or the fund can pay anytime sooner. During this period the plan continues to earn the return on the fund without penalty and participants are still able to transfer and withdraw their balances daily at book value. 
  • Quality Distribution – set by rating agencies of underlying securities consistent with the Investment Guidelines.
  • Revenue sharing or Administrative Reimbursement Revenue – determined by the fund, the Plan Sponsor and/or the TPA.
  • Sector and Duration Distribution - portfolio can be comprised of government securities (GNMA, FNMA, FHLMC, etc.), United States Treasury Securities including Treasury Bills, Notes, Bonds, and Strips, United States Agency securities, Mortgage Backed Securities (MBS), Collateralized Mortgage Obligations (CMOs), Asset Backed Securities (ABS), Guaranteed Interest Contracts (GICs), bank instruments or FDIC options, corporate securities and cash. Emerging market debt and junk bonds are not typically permitted in SVFs in the Government Market.
  • Trading Agreements - a recordkeeping agreement.
  • Valuation Frequency - forward rate setting or unitization (like a money market fund).
  • Weighted Average Quality - typically AAA or AA in Government Markets.
  • Wrapper or Book Value Liquidity Guarantees – a guarantee of book value payments at the participant level.                    
Stable Value Fund Monitoring
 
Many investment fund managers and Plan Sponsors use a short tem index to “benchmark” SVF performance. The returns after investment management fees can be compared to the returns of three-year treasury notes, on a constant maturity basis, or other indices, such as T-bills, the Hueler index, the Ryan GIC index, bond indices or other.
  
Multi-Manager Structure and Wrap Contracts
 
As plan assets grow ultimate diversification may be accomplished via a multi-manager SVF structure. A multi-manager approach is structured so that the two or more SVFs are blended and seen as one at the participant level. Each SVF manager may provide its own wrapper or a global wrap provider may be sought. Given recent credit market conditions many wrap issuers are holding back on the issuance of new wrap contracts, or at least charging a higher fee for the wrap. Historically, wrap issuers require a MV/BV ratio of at least 95%. Typically, in a multi-manager structure, one SVF manager acts as the lead manager, manages the cash buffer and utilizes the expertise of the other SVFs as sub advisors to the portfolio.
 
In Summary
 
It is important to understand that a fiduciary is not responsible for the actual performance of a fund. A fiduciary is responsible for having a rationale or policy for the selection and monitoring of investment options. One SVF manager calls its SVF product the “don’t hurt me” option. This is expected by Plan Sponsors and its participants and beneficiaries alike.