Slumping equity markets could help stable value

Retirement investors took on more equity risk last year amid a rebound from the coronavirus pandemic, causing a slump in stable value industry assets after surging in 2020 when investors sought safety.

The stable value asset gains in early 2020 began to evaporate in late 2020 and in 2021, but the big questions for a possible stable value comeback in 2022 depend on the stock market, the bond market, interest rates and competition from money market funds.

"Participant flows tend to follow the stock market," said David O'Meara, New York-based director of investments for Willis Towers Watson PLC. "If stocks struggle, we expect to see participants retrench into money market and stable value. Conversely, if stocks rebound, participants will likely migrate back to the equity market."

For the five months through May 31, the S&P 500 index was down 12.8%. During this period the Bloomberg U.S. Aggregate Bond index was down 8.9%.

An erratic stock market and battered bond funds due to rising interest rates provide a one-two punch against investors that could help stable value funds, said Greg Jenkins, Dallas-based managing director and head of institutional defined contribution for Invesco Ltd. In this environment, stable value is "fulfilling its role in spades by providing downside protection to participants," Mr. Jenkins said.

Invesco's stable value assets under management of $40 billion in 2021 rose 4.27% from the end of 2020, according to Pensions & Investments' annual survey of the largest money managers. Invesco was one of the few firms to avoid declines in assets during this period. Aggregate AUM for the 25 largest stable value managers was $468.5 billion last year, down 5.3% from the year earlier, according to P&I data. The data reflect U.S. institutional, tax-exempt assets managed internally.

"Historically, volatility in the market — typically the equity market — has led to inflows into stable value options," said Michael Norman, Minneapolis-based senior managing principal and co-president of Galliard Capital Management LLC, a wholly owned subsidiary of Allspring Global Investments. According to P&I data, Allspring saw a 7.6% drop in stable value assets to $59.7 billion, a function of pandemic-induced inflows in 2020 and market-recovery-prompted outflows, Mr. Norman said.

Another source for potential stable value growth is from plans that offer only a money market fund for capital preservation.

Stable value crediting rates — the interest rate on a stable value contract — move in conjunction with interest rates, but they don't move as quickly — up or down — as money market funds. "It is very possible that in the early stages of a rapidly rising interest rate environment you could see the crediting rate of a stable value product not immediately start upward in lockstep with interest rates, due to the lag within the stable value products as they work through the contract rate resets and the impact of yield change," Mr. Norman said.

To illustrate, Mr. Norman compared the blended yield for the Galliard Stable Return Fund, excluding management fees, on March 31 for each of the last three years. It was 2.42% in 2020 vs. 2.12% in 2021 and 1.91% in 2022. "We see the trend that the overall yield of the fund has been decreasing over the past three years, following the general trend of interest rates (going) down," said Mr. Norman, adding that it was too early to see the effect of rising rates due to the lagged stable value response.

During periods of low interest rates, stable value and money market options have been hurt. For example, a Willis Towers Watson survey of stable value managers reported the median crediting rate for the first quarter of 2022 was 1.5% vs. 2.5% in 2019, Mr. O'Meara said.

It was still a better return than a money market fund. When Morningstar Direct compared annual returns for stable value funds vs. money market funds in its universe between 2012 and early 2022, it found the former always outperformed the latter.

From 2012 to 2015, for example, annual U.S. money market returns were 1 or 2 basis points while stable value returns ranged from 1.37% to 1.84%.

The only times the spread narrowed appreciably were in 2018 when the stable value return was 1.89% and the money market return was 1.38% and in 2019 when the respective returns were 2.15% and 1.69%. Last year, stable value's return was 1.37% vs. money market's return of 2 basis points. Through April 30, stable value returned 41 basis points vs. 1 basis point for money market funds.

Years of low interest rates have enabled stable value to play a bigger role in defined contribution plans' capital preservation strategies.

Forty-nine percent of DC sponsors offered only stable value for capital preservation, according to an annual study published in February by MetLife Inc., based on interviews with 222 DC executives. Thirty-three percent of plans offered both options, 15% offered only money market funds and 3% offered unnamed other options.

A similar MetLife survey in 2015 reported that 38% of plans offered only a stable value fund, 45% offered both and 18% offered only money market funds.

"Stable value is a unique asset class for defined contribution," said Warren Howe, MetLife's New York-based national director for stable value markets. "Stable value has the ability to smooth volatility."

MetLife did not break out its stable value assets in the P&I survey.

Although sponsors prefer offering stable value over money market funds for capital preservation, participants' preference for equity and target-date funds, especially during the bull market of the past decade, has eroded stable value's role in retirement accounts. In 2012, stable value represented a 19% asset allocation for participants, according to the 401(k) index compiled by Alight Inc., Lincolnshire, Ill. By 2021, stable value was down to an 8% allocation. The 401(k) index reflects activity of more than 2 million participants with more than $200 billion in Alight record-keeping accounts.

Capital preservation trends have prompted consultants and advisers to overwhelmingly favor stable value vs. money market funds.

A survey published in May by Pacific Investment Management Co. LLC, Newport Beach, Calif., reported that 81% of consultants to large DC plans said stable value was their top choice for capital preservation vs. 15% for money market funds. PIMCO surveyed 26 DC consultants who represent clients with $5.7 trillion in assets.

The same attitude held true for a companion PIMCO survey of 10 consultants and advisers to smaller plans responsible for $1.2 trillion in client DC assets. Seventy-eight percent said stable value was their top choice and 22% preferred money market funds.

Conversations with DC consultants often yield the words "long-term investor" when they discuss their preference for stable value vs. money market funds.

Most of Callan LLC's clients only offer stable value, and that's the usual recommendation by the firm, said Kyle Fekete, the San Francisco-based vice president and a fixed-income specialist in Callan’s global manager research group. "Generally, we won't see that kind of movement because they are long-term investors," Mr. Fekete said, referring to his doubt that sponsors might switch from stable value to money market funds if interest rates continue to rise.

As interest rates rise, "there may be some re-evaluation by sponsors," said Mr. O'Meara of Willis Towers Watson, referring to the prospect of improving returns from money market funds."We don't encourage market timing." A majority of his clients offer stable value or money market funds but not both.

Mr. O'Meara didn't identify a tipping point that might encourage participants to switch. Possible selling points for money market funds are that they are more easily understood by participants and that sponsors believe a money market fund would be more familiar to participants, he said. Mr. O'Meara recalled the strategy of one client who still remembers the 2008-2009 economic crisis and who has insisted on offering only a money market fund. "You can't argue with emotion," he said.

Even as interest rates and money market rates improve, Invesco's Mr. Jenkins said he doubted participants would be jumping back and forth between stable value and money market funds, and he doubted sponsors would be switching options due to the spread in returns between the two options.

"In this kind of environment, you don't try to trade" among capital preservation options, Mr. Jenkins said. "I think most managers are preparing for this (rising-rate) environment."

Stable value providers guard against massive switching by participants with an "equity wash." This is a requirement that plan participants who want to move from a stable value fund to a money market fund must first put their money into a non-competing investment, such as an equity fund, for a certain period — usually 90 days — before investing in the money market fund. Putnam Investments, for example, requires a 90-day equity wash for clients who want to have both a stable value fund and a money market fund, said Steven McKay, Boston-based head of global defined contribution investment only.

Putnam's stable value business bucked the industry trend in 2021, according to P&I data. Last year's assets under management of $14.8 billion for U.S. institutional tax-exempt clients was 20.6% higher than the year before. AUM grew to $15.1 billion by April 30. Like its peers, Putnam enjoyed big inflows into stable value in 2020, only to experience "a reversal in trading" in 2021, Mr. McKay said. The overall gain was aided by an increase in new business, he said.

The Putnam Stable Value Fund has had inflows in 24 of the 27 months that ended in May 2022. Outflows were recorded in February-April 2021 as participants added more equity risk to their portfolios. "We continue to see positive flow trends and a solid growth trajectory." Mr. McKay said. The fund's crediting rate was 2.38% as of Dec. 31 and 2.34% as of April 30.

Another stable value provider that didn't follow the asset trend decline in 2021 was Great-West Investments, the asset management arm of Empower Retirement.

The company's organic stable value business mimicked its peers, experiencing large stable value inflows in the early months of 2020 and giving up some gains in 2021, said Jonathan Kreider, the Greenwood Village, Colo.-based senior vice president and head of Great-West Investments. Overall organic growth was up, but most of Empower's stable value gain in 2021 was due to the acquisition of Massachusetts Mutual Life Insurance Co.'s retirement business, Mr. Kreider said.

Last year's stable value AUM of $18.07 billion was 116.4% higher than the $8.35 billion in 2020, according to P&I data.

Empower's stable value footprint will be a lot bigger when 2022 data are compiled. In April, Empower completed its acquisition of the retirement business of Prudential Financial Inc.