A dilemma, says Webster’s Third New International Dictionary, is “a situation involving a choice between two equally unsatisfactory alternatives.” That describes the position that defined contribution (DC) plan sponsors find themselves in, regarding what should be a simple component of their plans—investment options intended to preserve capital. But both of the most widely used options, money market funds and stable value accounts, have shown their weaknesses in recent years, so there is no compelling choice.
The idea behind a capital preservation option is granting participants a shelter for their hard-won assets when conservatism is warranted—such as during extreme market conditions—or to accommodate a preference for steady asset values. And while they are ubiquitous in DC plans, or nearly so, there is no absolute requirement under the Employee Retirement Income Security Act (ERISA) that sponsors offer them, says Andrew Oringer, a partner in the New York City office of law firm Dechert LLP, and head of its national fiduciary practice. Still, he adds, “I think participants want to see capital preservation investments as options in their plans and that the employer may well want to be able to say it has offered an option under which it’s less likely people will lose their money.”
Consultants and recordkeepers report on stable value and money market options in their surveys, but the prevalence of each type depends on who is counting. Of the 1,900 plans surveyed in 2015 for The Vanguard Group Inc.’s “How America Saves 2016,” money market funds were present at 72% of plans and stable value accounts at 57%.
In a 2016 client survey by consultants NEPC, however, 38% of plans offered money markets, 47% provided stable value, and 15% presented both.
Although the two options hold similar positions at the conservative end of the investment risk continuum, their returns have been worlds apart. The table (see page 56) shows that, for the five years ended this past December, stable value accounts returned an annual average of 1.84%—somewhat better than short-term high-quality bonds—while money market funds earned next to nothing, the result of central banks’ ultra-easy monetary policy after the financial crisis. Those results are reflected in investors’ holdings: At year-end 2016, participants at recordkeeping clients of Aon Hewitt held 10.5% of their portfolios in stable value, versus just 2.1% in money market funds.
In view of the significant and persistent differences in returns, it might seem logical that, over the last few years, sponsors would have substituted stable value accounts for money market funds, or at least increasingly offered them as a further option. An overt opportunity for such a switch arose last October, when new regulation on prime money market funds, which are offered by many DC sponsors, made them impractical.
Under the tightened Securities and Exchange Commission (SEC) regulation, “if a sponsor wants to offer a prime fund, the recordkeeper has to be willing to handle potential redemption fees and gates on liquidity, so there are new operational complexities,” explains Ross Bremen, defined contribution specialist and a partner at NEPC in Boston. “Many in the industry thought we might see a big move to stable value,” he adds.
But the move was not meant to be. Notwithstanding the better historical yields on stable value funds, sponsors remembered the challenges during the financial crisis. “Stable value accounts were hit by the one-in-a-million event, and the ratios of market value to book value dropped to the low 90% level across the board,” Bremen recalls. As the crisis played out, sponsors had to closely monitor their stable value arrangements, and, even though the episode ended well, many sponsors developed “stable value fatigue,” as he puts it.
“Sponsors have had the opportunity to buy both types of fund for decades,” says Winfield Evens, director of outsourcing investment strategy at Aon Hewitt, in Lincolnshire, Illinois. “But the changes to prime money market funds were not a big catalyst.” The SEC did not require an overhaul of money market funds investing in government securities, given their assets’ higher credit quality, and those funds continue to offer the familiar constant pricing at $1 per share.
“Adding a stable value fund in late 2016 would have required learning the new product and a search for a new manager, and then harder monitoring once it was in the plan,” says Bremen. “Thus, many sponsors made the move to government money market funds.”
Still, “many sponsors went back to the drawing board to see that they had done a robust search and not just moved to their current providers’ alternative solutions,” notes Matt Brancato, head of defined contribution advisory services at Vanguard, in the leafy Philadelphia suburb of Valley Forge.
“So despite all the talk of differences in yields and the safety of one vehicle versus the other,” says Bremen, “the proportions of sponsors in stable value versus money markets are virtually identical to what we saw five years ago.”
Sponsors are not changing this basic but essential aspect of their plans, but should they? Here is one way to view it: Money funds are simple but do not yield much; stable value has better yields but is complicated and brings an additional layer of fees. If a given plan’s participants do not rely much on their capital preservation options—which may be the case as target-date funds (TDFs) grow in share—sponsors and participants may be able to get by with the minimal income earned by money markets. But if during tough times the work force turns to capital preservation, sponsors might switch over to stable value or add it to the menu, being sure to explain the reason behind the move and what both fund types achieve.
In view of the dilemma of stable value’s complexity on the one hand, and the chronic low returns of money market funds on the other, some in the industry have in mind a third way. “We’ve been thinking of a new custom option for larger plans,” says Susan Czochara, head of engagement for retirement solutions at Northern Trust Asset Management in Chicago. “[This would be] an ultra-short fixed-income strategy that would combine money market instruments with short-duration bonds in one portfolio and [would] change its allocation based on market conditions. It wouldn’t have an insurance wrapper like a stable value account has, but it would have the ability to move in or extend maturity depending on where the returns are expected to be better.”
At Willis Towers Watson, senior investment consultant Daniel Lomelino also in Chicago, echoes such an idea: “We are starting to look at funds that are short duration, going a little beyond money market funds, and [that] would have a floating net asset value.”
He adds, “It’s too early to suggest that money market funds or stable value accounts will disappear from 401(k) plans, and we wouldn’t expect a massive move, but the industry is thinking about all the viable options.”