The changing economic climate and greater regulatory uncertainty — combined with diminishing wrap capacity and consistently lower yields — have reduced the stability and value that investors can expect from stable value investment strategies, according to global professional services company Towers Watson (NYSE, NASDAQ: TW).
In its white paper, Assessing Stable-Value Strategies: What Plan Sponsors Should Consider , Towers Watson asserts that investors should be aware of a few notable changes brought on by a combination of an underlying structural change and recent economic and market stress, notably limited wrap capacity; tighter investment guidelines; higher fees; and the potential for an increasing interest rate scenario.
“While stable value investment strategies have performed relatively well during the past few years compared to money market strategies, we believe the changed environment means investors should revisit these with a view to understanding all the risks now associated with this investment strategy,” said Peter Schmit, research manager in Towers Watson’s investment business and coauthor of the paper. “Regardless of upcoming regulatory decisions, we believe there has been a structural shift in competitive advantage away from plan sponsors and stable-value managers over to insurance providers and the investment strategy now faces distinct market risks and regulatory headwinds.”
According to the research, stable value has long been a popular investment option in defined contribution (DC) plans, as plan participants have appreciated the principal preservation, benefit responsiveness, liquidity and consistently higher returns compared with money market options, with a similar risk profile.
However, Towers Watson notes that plan sponsors should be aware of the type of events that may trigger a violation of the wrap agreements and cause a potential market-value adjustment, such as a workforce reduction or the addition of a competing fund option (money market or self-directed brokerage option) within the DC plan.
Such risks include counterparty, term, credit and liquidity (at the plan level) and are exacerbated by:
Complexity
Lack of standardization
Less-than-ideal transparency
Changing markets prompted by uncertainty over Dodd-Frank, swap legislation, diminishing capacity and evolution of the wrap market
The reality of higher wrap fees and lower yields
“We have been discussing stable value with our clients for a number of years, specifically with an emphasis on the education and oversight of the complex structured product,” Schmit said. “As a plan sponsor fiduciary, it is important to understand the wrap issuer market and the developments within the wrap market, as well as the risks associated with stable value. Ultimately, those who are armed with the best information will make the wiser investment choices as they relate to this issue.”
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