Do More Than Check the Capital Preservation Box
When it comes to Savings Plans, we believe the Capital Preservation offering should go beyond simply preserving the value of money invested. These investors are exposed to inflation risk, and even at modest levels it can erode balances, which is why we believe Stable Value deserves serious consideration. Money Market Funds have their place in the world, but we do not believe that place should be in your Savings Plan.
The Stable Value Advantage
All Savings Plans offer a Capital Preservation option as part of a diversified investment menu. The two most common options available within Defined Contribution, 529 Plans and other similar type Savings Plans are Stable Value and Money Market. It is undeniable that Stable Value presents a significant historical return advantage, with much less volatility, which it accomplishes by investing further out on the yield curve, with a broader investment opportunity set than other principal-protected strategies. These strategies are then paired with wrap contracts issued by third-party insurance companies that smooth out returns over time. These characteristics allow Stable Value a natural return advantage from the higher expected returns for longer-maturity investments. It is typically only in a prolonged rising rate environment would you expect Money Market to approach Stable Value yields, but as you can see in the chart below, such occurrences are typically short-lived (Exhibit 1). In addition, the benefits of Stable Value do not end there, when compared to short-to-intermediate term bond funds, they have historically delivered similar returns with less volatility, and unlike bond funds, when interest rates rise, Stable Value will not lose value.
Exhibit 1: Historical Returns for Stable Value and Money Market
In this remarkably uncertain period of time, the one thing that is fairly certain is that the Federal Reserve will be keeping rates at zero for a long time.
Head of Short Duration JPMAM
Money Market ≠ Capital Preservation
Savers cannot afford to have their capital preservation investment decline, which is exactly what occurs when Money Market returns are adjusted for inflation – the actual purchasing power declines over time, and the real value is worth less than the original investment. It wasn’t too long ago, during 2009-2015, that Money Market Funds produced returns analogous to stashing your money under the mattress. Stable Value on the other hand has a proven track record of real Capital Preservation. Given the number of challenges retirement and college savers face, from market risk to longevity risk, Stable Value has the potential to really improve participant outcomes.
Exhibit 2: Growth of $100k adjusted for inflation
We have seen this movie before
With the Federal Open Market Committee (FOMC) expected to keep rates at the 0.00-0.25% target rate for the next several years, we find ourselves in a similar environment to the period following the Great Financial Crisis. As for inflation, even at fairly muted levels (sub-2%) in the near-term, will still erode participant balances. As illustrated in the Exhibit 2, this can materially affect participant outcomes. Of note, the FOMC’s new average inflation targeting framework explicitly state two conditions need to be met in order for the Committee to consider adjusting policy rates: 1) inflation would need to run moderately above 2% for a period of time to compensate for periods of low inflation, and 2) longer-term inflation expectations would need to remain anchored at 2%. Looking ahead (Exhibit 3): we believe the FOMC is on hold until maximum employment and inflation is on track to moderately exceed 2% for some time; and the markets agree, with current projections not anticipating a change in the Fed Funds rate until 2024. From an investment perspective, Stable Value assets are typically invested in fixed income sectors such as treasuries, corporate debt, agency and commercial mortgage-backed securities and asset-backed securities. Many of these sectors have benefited from the Fed programs and fiscal stimulus, resulting in spreads retracing most of 1Q20 volatility. Additionally, we see high demand in many of these sectors as yield starved investors look further out the curve.
Exhibit 3: Historical and projected yields
The ease of converting to Stable Value
With Money Market rates at or near zero and the Federal Reserve expected to remain on hold, we believe there is no better time to make sure you have the optimal Capital Preservation option to help your plan participants achieve their retirement and savings goals. Additionally, Plans that offer both Stable Value and Money Market may want to consider consolidating to a single Capital Preservation option to optimize their offerings. Stable Value is uniquely designed for Savings Plans and there are a range of solutions in the market, from CITs to customizable separately managed accounts. A conversion from Money Market should be seamless with no participant disruption and the immediate pickup in yield could potentially increase participant satisfaction. As with any investment option mapping, a participant communication describing the Fund change would be required, as well as, transition of assets. The Stable Value manager will work with the Plan’s record-keeper to ensure participant fact sheets and education materials are available.
Forecasts, projections and other forward looking statements are based upon current beliefs and expectations. They are for illustrative purposes only and serve as an indication of what may occur. Given the inherent uncertainties and risks associated with forecasts, projections and other forward statements, actual events, results or performance may differ materially from those reflected or contemplated.