- Rising rates have contributed to the erosion of stable value’s yield premium over money market funds. But, despite increasing money market fund yields, stable value continues to outperform money market funds, as it has during most previous rate hiking cycles. Accordingly, plans and participants have benefited from investing in stable value during both falling rate and rising rate environments.
- Higher interest rates mean higher crediting rates for stable value. However, higher rates also mean lower prices, and lower prices translate to lower stable value market-to-book value (M/B) ratios. With a more transparent Fed and more moderate interest rate forecasts for 2019 and 2020, we do not expect M/B ratios to change significantly.
- The wrap industry remains strong and appears to have fully recovered from the 2008 financial crisis (Crisis) based on the healthy number of active providers and available capacity. By the fourth quarter of 2018, there were 17 active wrap providers, five more than in 2009, and nearly 35 billion USD in additional wrap capacity available to stable value managers.
Stable value strategies continue to offer a uniquely attractive risk/reward profile for defined contribution plans and participants who include principal preservation components, like money market and stable value funds, in their investment lineups.
In steady interest rate and falling interest rate environments, stable value, with its longer duration and higher risk profile, has typically produced a higher yield and outperformed other principal preservation options, like money market funds, by 100 to 200 basis points.
In rising interest rate environments, where the Federal Reserve is hiking rates and the yield curve is flattening, over time, the yield differential between money market funds and stable value portfolios will be reduced, potentially reaching a point where participants are indifferent and no longer incentivized to move money from money market funds into stable value portfolios.
Furthermore, in extreme interest rate environments, the Federal Reserve may hike rates to a point where the yield on money market funds exceeds the crediting rate offered by stable value portfolios. While periods where money market fund yields exceed stable value crediting rates—i.e., periods of disintermediation—have been rare, participants and plan sponsors may end up moving assets from stable value into money market funds to chase higher yields.
Brief Disintermediation With Slight Money Market Outperformance
Annualized Yield Comparison
As of December 31, 2018
Figures Are Calculated in U.S. Dollars
Past performance is not a reliable indicator of future performance.
In the chart above, we highlight periods of disintermediation over the two most recent rate hiking cycles, from 1999 to 2000 and from 2004 to 2006. As indicated in the chart, periods of disintermediation have been brief (on average, 12 months) and the amount by which money market fund yields exceed stable value crediting rates has been slight (5 to 50 basis points) (Sources: T. Rowe Price, Bloomberg, and Hueler Analytics).
Despite increasing money market fund yields during previous rate hiking cycles, stable value outperformed money markets during most of those periods—and has continued to do so. As highlighted in Figure 2 on page 3 of the full article, stable value, with its longer duration and higher risk profile, outperformed money market funds and low-duration fixed income strategies, like ultra short-term and short-term bond, through periods of Fed tightening. As was the case in prior rate hiking cycles, plans and participants have benefited from investing in stable value during the current rate hiking cycle, which began in December 2015. Stable value has proven to be an investment option for multiple market and interest rate environments.
1 The benchmark is the Hueler Analytics Stable Value Pooled Fund Index (Hueler Pooled Fund Index). The Hueler Pooled Fund Index is provided by Hueler Analytics, Inc., a stable value data and research firm, which has developed the Hueler Analytics Stable Value Pooled Fund Comparative Universe (Universe) for use as a comparative database to evaluate collective trust funds and other pooled vehicles with investments in GICs and other stable value instruments. The Hueler Pooled Fund Index is an equal-weighted total return average across all participating funds in the Universe and represents approximately 75% of the stable value pooled funds available to the marketplace. Universe rates of return are reported gross of management fees. Hueler Index statistics are presented for comparative purposes only. Any further dissemination, distribution, or copying of the Universe data is strictly prohibited without prior approval or authorization from Hueler Analytics.
2 Source of Lipper data: Lipper Inc.
3 Bloomberg Barclays U.S. Intermediate Government/Credit Bond Index is a component of the Bloomberg Barclays U.S. Government & Credit Index. The Government & Credit Index includes securities in the Government and Credit Indices. The Government Index includes treasuries (i.e., public obligations of the U.S. Treasury that have remaining maturities of more than one year) and agencies (i.e., publicly issued debt of U.S. government agencies, quasi-federal corporations, and corporate or foreign debt guaranteed by the U.S. government). The Credit Index includes publicly issued U.S. corporate and foreign debentures and secured notes that meet specified maturity, liquidity, and quality requirements. There is no standardized, industry-accepted benchmark for stable value portfolios. All information on this page is provided for illustrative purposes only.
Money market and stable value funds have different risks. It is important that you carefully review the legal documents for each type of vehicle prior to investment to determine if it is appropriate for you.
This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action. The views contained herein are those of the authors as of March 2019 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.
This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.
Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.
Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only.
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