Tom Schuster, vice president, Stable Value and Investment Products, and Warren Howe, national sales director of Stable Value Markets, both at MetLife, spoke with Alison Cooke Mintzer, editor-in-chief of PLANSPONSOR, about how these investment products have served plan sponsors and participants before, through and since the 2008/2009 financial crisis—and how more flexible investment guidelines could lead to higher returns from this low-risk product without adding risk.
PS: What makes stable value an attractive defined contribution plan option?
Schuster: Stable value is not new. It’s been around for over 35 years. The features of principal preservation, safety and stability resonate with the end consumer—plan participants—because it allows them to diversify their asset allocation.
What’s unique about stable value, as an option, is that it was designed specifically for defined contribution plans. The returns on the asset class have been historically higher than money market funds and are generally comparable to those of high-quality intermediate-term bond funds, but with significantly lower volatility. About half of all defined contribution plans offer a stable value option, and industry estimates show that participant allocations to stable value range from about 17% to 37% of DC assets.
Howe: What makes stable value attractive is the value of the guarantees and the certainty that it delivers to the plan participants, especially during uncertain times. It’s great that it provides stability for plan sponsors—they need to offer a capital preservation option, so it meets that need—but it’s really the plan participants themselves who find the value from those guarantees and from the certainty that it delivers.
Schuster: Its history has allowed stable value to be examined in a number of market cycles, including the financial crisis. The asset class as a whole has consistently delivered—even during the most challenging times—and continues to thrive because of the value that it provides.
PS: Can you describe the purpose of the stable value investment guidelines and the parameters that those guidelines typically address or cover?
Howe: Investment guidelines are designed to provide carefully outlined parameters for asset managers regarding how they can manage any given investment portfolio. It gives them the outline for how to manage these portfolios and how to generate the returns they seek to provide, while also balancing the level of risk that the plan sponsor and the wrap provider are comfortable assuming.
Schuster: The goal of the investment guidelines’ duration constraints is to have the credited rate on the stable value option move in the direction of prevailing interest rates. Doing so ensures participant satisfaction with the option and brings the value of participants’ account balances into alignment with the market value of the underlying assets.
Howe: Guidelines are a protection for both plan sponsors and plan participants. It provides them with an idea of how a portfolio manager may manage the portfolio. Without specific investment guidelines in place, there is the potential for a lack of understanding of the risks being taken within the portfolio. So, by having these guidelines in place, everybody’s very clear—the wrap provider, plan sponsor and investment manager—as to exactly how they can manage the portfolio so that there are no surprises.
Schuster: The clarity allows the contract issuers to provide stable value protection at a price that still delivers exceptional value to participants. The goal of the guidelines should be a balanced risk approach, which allows the issuers to feel comfortable with the risk that they’re taking on but also provides value for the participants via the credited rate feature.
PS: How would you characterize the investment strategies that were prevalent during and after the financial crisis of 2008 and 2009? Can you talk a little bit about the evolution since then and what we are seeing today in the investment strategy community?
Schuster: Pre-crisis, stable value guidelines were very broad and flexible. In the wake of the financial crisis, investment guidelines became both more conservative and more precise. Guideline construction became more explicit with higher overall credit qualities, a move towards shorter-duration portfolios, with more clarity on the specific quality and issuer parameters for each type of permissible sector, as well as a tightening on the duration collars and counterparty requirements.
Howe: Pre-, during- and now post-crisis, I look at it as a pendulum—the way guidelines used to be, the way guidelines are now and maybe where the guidelines should go in the future.
Before the financial crisis, you didn’t have as true an appreciation of risk as you do now, so some firms sought different ways of achieving additional yield and took on additional risk in portfolios. Then the financial crisis hit, and you got the pendulum effect. The guidelines swung to become conservative, there were a lot of changes to ensure clarity and specificity, as well as an overall de-risking of portfolios.
The guidelines were too far one way, and they may have gone too far the other, and now they should be settling back into equilibrium, which is where we think they’re starting to move now. People recognize that there’s a changing, evolving market and that the investment guidelines need to change and evolve with it.
PS: Have more stringent guidelines made stable value, as an asset class, stronger?
Howe: The whole re-evaluation of risk and this focus on the clarity and the specificity in the investment guidelines, combined with the return to more historical norms on fees and contract provisions, help attract more wrap capacity participants. All of that has made stable value a bit stronger coming out the other side of the financial crisis.
PS: Have investment guidelines become too conservative for current market conditions? Do you think more flexibility is needed, or do you think that they are still in the right place?
Schuster: A reasonable case can be made that the guideline changes that fit the market parameters during the crisis and its recovery are now too stringent and, in some cases, more commoditized than what is necessary for the current market environment. Guidelines should always appropriately reflect the current risk environment that you’re in, but the degree of adjustments made on investment guidelines should also ideally reflect the manager’s specific style and performance history. Any adjustments to investment guidelines must be made based on a manager’s level of expertise and way in which his strategy seeks to add value.
Howe: Yes, and it’s clear that the financial crisis brought about this whole re-evaluation of risk across the fixed-income market. That brought risk in a little bit, which tended to create a block of business that became homogeneous. All the guidelines were structured in the same fashion.
Quite frankly, that was needed during the crisis. You needed to control how things were happening and the way the books of business were being managed, to make sure everybody had a clear understanding of the risk profile. But now, six years later, it’s a question of how the markets have evolved, and how should guidelines?
Just like they changed during the financial crisis, there’s an opportunity now to take advantage of the current economic environment and start to liberalize guidelines somewhat, but to do so while still recognizing risks and not forgetting about the lessons from 2008.
Schuster: The guidelines should always be viewed as a dynamic process and as limitations and restrictions that are necessary in a given market environment. When markets improve, you need to allow investment managers to respond optimally to the current market.
PS: How could such flexibility or changes in investment guidelines benefit plan sponsors and plan participants?
Howe: Plan sponsors and participants benefit from these types of changes in that it would enable them to take advantage of the strengths and expertise of the asset managers that they’ve hired for these strategies. Each manager has certain strengths, and if you have a homogeneous set of guidelines where everybody’s managing in the same manner, they don’t necessarily get to demonstrate these strengths.
With more flexibility, it’s specific to each asset manager. If a particular firm has a strength in a certain sector, we believe you should give them more latitude in that sector to take advantage of what they’re best at, but dial back the risk somewhere else where it’s maybe not a strength of that firm. If you do that, in the end, the returns that they generate from their excellence in a certain structure pass through the crediting rate to the plan participants.
Schuster: Any increased flexibility would be expected to increase the rates credited to participants. As Warren noted, each manager adds value in a different way. Some managers utilize a top-down approach where they analyze broad sector and economic conditions to determine individual security selection. Others utilize a bottom-up approach where they select securities based on individual company attributes. Others are specialty managers that have strong capabilities in a given sector, and others add value by yield and duration curve positioning. We evaluate managers and, based on how they add value, allow for the construction of specific guidelines to allow them to add value in the way that they have demonstrated expertise.
PS: Are there best practices then that would enable the stable value fund managers to marry these investment guideline return expectations with liability risk?
Schuster: Within the current risk environment, standard guidelines are always a good starting point, but in order to recognize the true value that each manager brings to the table, we allow for trade-offs based on managers’ various strengths—as should, we believe, others in the industry.
Howe: Ideally, guidelines should provide manager-specific latitude that’s aligned with their expertise, while adjusting in other areas so that guidelines remain risk-neutral overall. That’s the philosophy that we employ.
PS: Are there certain stable value contract structures that might better lend themselves to this flexibility than others?
Schuster: Some stable value contract structures may better lend themselves to increased manager flexibility while preserving good risk control. A separate account insurance company structure is positioned to achieve both of these objectives. This type of structure combines the benefit responsive features of a traditional guaranteed interest contract (GIC)—i.e., guarantee of principal and interest, book value accounting—with added investment flexibility, control and security.
PS: For plan sponsors, what are the benefits of working with a stable value provider that also plays a fiduciary role?Howe:
The important aspect of having partners in this business that have a fiduciary role and understanding is that, because they have that fiduciary responsibility, they act in the best interest of the plan participants, above their own interests. That’s comforting to plan sponsors, to know that the provider will put the good of the plan—and its participants—first.
« Successful Rollovers