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Stable Value Once Again Proves Its Stability
By: Paula Romanchuk, CFA, Consultant
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Despite the volatility and extreme market pullback investors experienced at the start of 2020, defined contribution plan participants mostly stayed the course in terms of their plan investments. One asset class where we have seen a slight uptick in flows is stable value. This is not surprising given the high-quality nature and capital preservation objective of stable value mandates; in fact, there was a similar trend during the 2008-2009 global financial crisis (GFC). That said, there have been some key changes to the stable value market over the last decade, and these characteristics are important to understand recent performance and to set expectations for asset class returns moving forward.
At the end of 2007, stable value assets totaled $520 billion, growing to $840 billion by the end of 2019. From a performance standpoint, stable value funds generated modest positive returns during the GFC and the COVID-19 pandemic. Stable value returned 4.5 percent and 2.7 percent in 2008 and 2009, respectively, and 0.6 percent in the first quarter of 2020¹. However, liquidity and overall market dynamics were more challenged during the GFC. Several factors contributed to those challenges from a decade ago, including the composition of the assets underlying stable value funds as well as the financial health of the wrap providers.
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During the GFC, some stable value managers held lower-quality fixed income securities, including high yield and emerging markets debt. As a result, when the crisis hit, riskier assets suffered, and the market values on those securities fell dramatically. The key market-to-book ratio metric, often referenced to assess the condition of a stable value fund, reflected this major decrease in value. That value varied by fund but averaged in the mid- to low-90s. Amid such volatility, there was decent demand for stable value, so fortunately most managers were not forced to liquidate portfolios when market values were trading below book values. Eventually, market values recovered, and the average market-to-book ratio increased, nearing the prior 100 percent mark.
Following the GFC, investment guidelines for stable value portfolios became more stringent, limiting available investments in portfolios, to better avoid severe drops in market-to-book ratios. Today, most stable value managers hold a mix of high-quality short-duration government, corporate and securitized bonds. The higher-quality nature of these securities provides more downside protection in periods of market volatility, and, over the first quarter of 2020, market-to-book ratios remained close to 100 percent. Also, similar to the last crisis, stable value funds experienced inflows year-to-date, and managers have not been forced to sell into a weak and illiquid market.
In addition to portfolio composition, the stable value market has also seen a significant change in industry players, specifically providers of wrap, or insurance contracts. Before the GFC, many insurance companies and large banks were actively growing their wrap business; however, once the crisis hit, many gained a greater appreciation for the risks accompanying this business, ultimately deciding to exit. During the GFC, many companies halted wrapping new business, which had a downstream impact on stable value managers as wrap capacity shrunk, forcing managers to close strategies despite the uptick in demand.
Today, many of the large wrappers are insurance companies that have strong risk management tools. As such, they are likely better positioned from a balance sheet perspective compared to most financial institutions in 2007. In addition, the fees that wrappers are charging to provide the insurance on stable value funds increased in recent years, which is another sign of more prudent risk management. During the COVID-19 pandemic, wrap capacity has not been constrained and many stable value funds continue to welcome positive inflows.
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While today’s market volatility may persist for quite some time — and the economic data continues to look grim — we expect the stable value market to continue to perform as prescribed. Fixed income markets could experience more pressure in the coming months, but we believe our favored stable value funds are positioned to weather the storm and effectively operate as capital preservation options within defined contribution plans.
For more information, please contact any of the professionals at DiMeo Schneider & Associates, L.L.C.
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Sources: Stable Value Investment Association (SVIA) and Valerian Capital
1 Ryan Labs 3 Year GIC Index
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This report is intended for the exclusive use of clients or prospective clients of DiMeo Schneider & Associates, L.L.C. Content is privileged and confidential. Any dissemination or distribution is strictly prohibited. Information has been obtained from a variety of sources which are believed though not guaranteed to be accurate. Information has been obtained from a variety of sources believed to be reliable though not independently verified. Past performance does not indicate future performance. This paper does not represent a specific investment recommendation. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice.
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