17 August 2021 / STABLE VALUE
Stable Value Ready for a Higher Profile
Stable value primed for increased interest amid low rates.
- Stable value navigated the coronavirus pandemic-related market shocks, with assets growing markedly over the past 12 months.
- Relative to money market funds, we believe stable value products continue to maintain a significant yield advantage in this low interest rate environment.
- Even in a rising rate environment, stable value can be a compelling option in the principal preservation space.
Stable value products weathered the coronavirus pandemic and the global economic fallout remarkably well. In their first major adversity test since the 2008–2009 global financial crisis (GFC), stable value portfolio assets grew by more than 10% in the one-year period ended December 31, 2020, according to the Stable Value Investment Association. The wrap industry, which underwent reforms following the GFC, also proved resilient.
Historical Market-to-Book Ratios
(Fig. 1) Market-to-book ratios were stronger heading into the recent crisis
In the runup to the 2020 crisis, stable value funds were in a much better position, in terms of guidelines, crediting rates and market-to-book ratios, compared with 2008. As a result, market-to-book ratios held up much better following the pandemic relative to where they were after the GFC.
Low Rates Present Challenges for Money Market Yields
With the Federal Reserve maintaining its accommodation for the near term, stable value can potentially offer similar returns to short-term bond funds, likely outpacing money market funds. Stable value crediting rates have continued to outpace money market fund yields as the Fed has maintained short-term rates at near zero. Indeed, the current yield advantage is consistent with prior low rate environments over the past 20 years. Currently, stable value’s yield premium over money market funds is at the higher end of its historical range.
Given the lack of yield in money market funds, stable value has experienced an increase in flows. With the Fed likely on hold through 2022 and the potential for a steeper yield curve, this trend could continue. Relative valuations, ample wrap capacity, money market reforms, and litigation following the global financial crisis involving plan sponsors who did not offer a stable value option all combine to keep stable value an attractive option for plan sponsors.
Annualized Yield Comparison
(Fig. 2) Stable value can offer a yield advantage to money markets
Past Rising Rate Environments Display Stable Value’s Potential
Despite the Fed’s posture, markets have in recent months become more volatile amid increased inflation. While there is evidence that higher inflation readings are a result of the base effects from the coronavirus pandemic, market participants are clearly split regarding the endurance of inflation and whether rates will recede in the ensuing months. But the debate over inflation is certainly a highly relevant one, and investors may want to be mindful that in a rising rate environment, stable value can outperform low duration strategies like ultra short-term and short-term bond funds, as well as money market funds.
This combination of a relative yield advantage and potential outperformance in rising rate environments has helped to fuel continued inflows into the stable value asset class. Moreover, it has spurred greater interest and adoption of stable value by plan sponsors and other financial professionals.
Recent Changes Simplified Stable Value
In addition to potentially strong performance and flows, we continue to see product innovation in the stable value space as managers negotiate more flexible contract terms with wrap providers to increase usage and availability.
For example, several stable value funds have waived the 90-day equity wash provision for self-directed brokerage accounts. Moreover, several funds have reduced their competing fund definitions from three-year duration fixed income investment options down to a 2.5- and a 2-year fixed income investment option in order to streamline the use of stable value for plan participants.
In this period of strong market-to-book ratios, some funds have relaxed enforcement of exit provisions, commonly called put provisions, and permitted early payouts of account terminations.
Lastly, we continue to see stable value expand availability across recordkeeping platforms in addition to increased usage as a standalone investment option. The product is also more commonly featured as a building block in target retirement date products, other comingled products, and managed accounts.
Historical Rate Hiking Cycle Yield Curve Change
(Fig. 3) Stable value has fared well in a rising rate environment
With stable value an attractive principal preservation investment option relative to money market funds, plan sponsors are giving stable value a second look and considering adding stable value to their plan line-ups.
Stable value can be an attractive investment option for investors seeking principal preservation and liquidity. With some of the volatility and uncertainty surrounding the events of 2020 subsiding, many retirement investors could begin rotating back to riskier parts of the market.
The Fed, however, has been transparent about its trajectory for policy rates and willingness to let core inflation run above 2%. This environment could create more risk for longer maturity assets through a potentially steepening yield curve. A gradually rising rate environment, however, should support stable value products, which feature shorter duration profiles than many bond funds while investing in higher-quality securities. Stable value product offerings are more flexible and easier to implement than in years past. Greater flexibility has led to wider adoption, availability, and greater usage both as a standalone investment option and as a building block in other investment options like target date funds and managed accounts.
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