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Heading for Higher Ground: Capital Preservation Options for Retirement Plans
By: Ryan Walter, Senior Consultant
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As a young man working at a golf course, the local golf pro would always be the first golfer to retreat from the course before a rainstorm. The pro would look at me and say, “Time to head for higher ground”; that is to say, he was not about to get washed away in a rainstorm. Sure enough, that rainstorm poured down five minutes later. Never a drop of rain would ever hit the pro nor would it graze his shiny golf clubs. When the pro would reappear from the clubhouse, emerging with certainty and a reassured gait, you knew the rainstorm had subsided. Back out to the course he went, often the first player to do so. His timing, as always – impeccable.
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Storms can often hit financial markets in much the same way, and when they do, investors often look to head to higher ground like that golf pro. Participants in defined contribution plans look to head to the plan’s capital preservation option, often a money market or stable value fund. No one can time the markets like the pro timed the weather. Nevertheless, participants know that their nest egg won’t get washed away if invested in a money market or stable value fund. With the recent pandemic-related storms in the market, plans have seen an increase in money market and stable value fund assets, causing the focus to shift toward capital preservation options among Plan Sponsors.
Money Market Funds
Money market mutual funds are the most “cash like” option for a defined contribution plan. A Treasury money market fund, as its name would imply, holds short-term Treasury Bills of the U.S. Government with typical maturities out to a maximum of one year. Other money markets include Government or Federal money markets that will hold short-term debt securities of U.S. Federal Agencies, such as the Government National Mortgage Association, “Ginnie Maes” in addition to Treasuries.
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Stable Value Trusts
A stable value trust will invest in a bond portfolio of many different issuers with longer maturities of typically two to three years. Therefore, a stable value bond portfolio will have a higher inherent risk than a money market fund. Stable value trusts alleviate the higher inherent risk through insurance company-issued wrap contracts. Insurance companies will “wrap” the underlying bond portfolio in insurance to prevent the loss of principal in the event of widespread bond issuer defaults.
There can be a few or many insurance companies that provide wrap coverage to a stable value trust. The greater number of wrap providers, the greater the insurance company exposure diversification. Insurance companies are compensated for bearing the risk of these portfolios through a wrap fee that currently averages around 0.15 percent annually of the principal insured. This wrap expense coupled with the investment management expense of the underlying bond portfolio produces an all-in fee that is typically higher than a money market mutual fund.
While the stable value trust guarantees that a participant can withdraw a dollar for every dollar invested in the stable value trust, a Plan Sponsor plays by a different set of liquidity provisions. In the event of a Plan Sponsor initiated change, the stable value trust may enact a 12- or 24-month put provision that would delay the withdrawal of the entire plan balance depending on the market value of the underlying bond portfolio.
GICs
A lesser known capital preservation option is a Guaranteed Investment Contract (GIC). With a GIC, the sponsor invests the participants’ dollars at a predetermined interest rate for a predetermined amount of time, which is credited to the participant. The interest rate will then adjust for another predetermined amount of time. GICs typically pay an attractive interest rate above those typically seen with money markets and stable value trusts but have little transparency and subject the Plan Sponsor to even more stringent liquidity provisions.
When it is time to seek higher ground, there are plenty of tradeoffs in selecting capital preservation options. Money markets will offer the best liquidity, but they typically pay the lowest interest rate during most market environments. Stable value may offer a slightly higher interest rate, but they limit liquidity to the Plan Sponsor at times. GICs will usually pay the highest interest rate to participants, but they may have the most stringent liquidity provisions to the Plan Sponsor with very little transparency.
To determine which option is best for your plan, speak with your DiMeo Schneider Investment Consultant.
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This report is intended for the exclusive use of clients or prospective clients of DiMeo Schneider & Associates, L.L.C. The information contained herein is intended for the recipient, is confidential and may not be disseminated or distributed to any other person without the prior approval of DiMeo Schneider. Any dissemination or distribution is strictly prohibited. Information has been obtained from a variety of sources believed to be reliable though not independently verified. Any forecasts represent future expectations and actual returns, volatilities and correlations will differ from forecasts. This report does not represent a specific investment recommendation. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice. Past performance does not indicate future performance and there is a possibility of a loss.
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