As you read your plan’s lineup, you see the following scores:
Large Cap Fund – 9 – Great!
Small Cap Fund – 8 – Good!
International Fund – 10 – Perfect!
Fixed Income Fund – 10 – Perfect!
Stable Value – — – Hmm…what does that mean?
Periodically you review your plan’s fund lineup; you place some funds on Watchlist, you replace under-performers and you continue to monitor those funds that score acceptably. But, you see a dash next to your stable value fund and wonder, what should you do? Traditional evaluation metrics can be difficult to apply to stable value funds. You can look at returns, but without an appropriate benchmark or a way to directly measure the risk taken by the fund, the market value performance number can be difficult to interpret. Perhaps fees can provide the answer, but there are wrap fees, investment management fees and trustee fees, all assuming there is a stated fee to review in the first place. What is a fiduciary to do?
While stable value fund due diligence can be intimidating, there are key differentiators among stable value funds that fiduciaries can review to document that a fund is a good fit for their participants. Ultimately stable value funds are not too different from other funds within a plan lineup and the strategies to evaluate them are similar. There exists an established methodology incorporated into your IPS for evaluating these standard funds. Let’s evaluate how well that framework can be applied to the stable value universe.
The first component for evaluation of the RPAG Scorecard is a fund’s style. Does the fund stick to its professed asset class? Do the same for a stable value fund’s portfolio. Is it allocating to assets and securities that are appropriate for a high-quality, short-term fixed income fund? Also evaluate the fund’s diversity of allocation. Monitoring its allocating across a variety of subsectors of fixed income (treasuries, corporate bonds, mortgage backed securities, etc.).
The next criteria is evaluation of risk and return. There are a plethora of data points for evaluating stable value fund risk and return. With regard to return, examine a fund’s crediting rate or its yield relative to the stable value universe to evaluate this fund’s performance. Similar to traditional funds, performance needs to be examined relative to the risk taken. For evaluating risk the underlying portfolio is important. Review the credit ratings of the underlying securities, verify the average duration or maturity relative to the funds’ peers, and evaluate the asset managers investing the underlying portfolio. Also review the number of wrap providers for the portfolio and their credit rating.
The final quantitative component of the RPAG Scorecard is peer group review. Once again a stable value fund’s evaluation can follow this same methodology. Evaluation of a fund’s market-to-book ratio, relative to its peers, is a key component of portfolio health and to identify potential issues early. Cash flows in and out of a fund relative to the universe give valuable insight to how quickly the portfolio can react to changing market conditions.
For qualitative components, look at the same key characteristics that are evaluated for standard funds, as well as a few unique characteristics to stable value. A long tenured and constant management team is important no matter the type of fund. Also, while there are additional fees in the stable value universe, evaluating them relative to the universe is still important. Unique to stable value is a fund’s exit provisions (is there a put, and if so how long) and the fund’s high yield policy to ensure both align with participant best interests.
Stable value funds seem unique, and they do have peculiar challenges when evaluating them, it’s still a crucial task for fiduciaries. The same process that has been established within the plan’s IPS to evaluate the core line-up, can be adapted to evaluate stable value funds in a similar manner.
All the data points identified as key components of evaluation can be found on the RPAG stable value fund factsheets.
|Stable Value Fund Terminology Cheat Sheet|
|Stable Value Funds||A cash alternative investment option within tax-qualified retirement plans. Typically invests in high-quality, short-term fixed income securities.|
|Wrap||An insurance contract purchased by the Stable Value fund that ensures participants are paid out at book value when they withdraw money.|
|Book Value||The value of the original investment increased by the stated crediting rate.|
|Crediting Rate||The set rate of the return the participants in the fund receives. The rate is reset at varying intervals depending on the fund.|
|Market Value||The value of the underlying portfolio of securities. Will often fluctuate around the book value.|
|Market Value Adjustment (MVA)||A liquidity restriction upon Stable Value funds that adjusts book value to market value upon an employer initiated event.|
|Credit Quality||The credit rating of the underlying securities within the portfolio|