Unstable Value Funds? (III)

Posted on by David Merkel

There’s a lot that I don’t know here, but what I do know concerns me.? Stable Value funds are a murky part of the market.? They are murky because they don’t report the value of the underlying assets, but only the smoothed value of assets, and the rate that they are currently crediting.? (Note: for those that want the grand tour of Stable Value Funds, I wrote this piece at RealMoney, The Biggest Asset Class You Never Heard Of.

Other articles I have written:

I have debated as to whether I should write a piece like this, but at this point I figure that someone will eventually point this out, so better for me to do it, than for it to come from another quarter.? Let’s start with the question, “How does a stable value manager manage the fund?”

In the old days, it meant buying Guaranteed Investment Contracts [GICs] from insurance companies, and buying the highest rate offered, because they were all AAA in the late 80s.? Even before defaults happened, the stable value funds found that there was not enough capacity in the insurance industry to write GICs at reasonable rates.? As a result, they began buying AAA assets in the structured product markets, and purchase wrap agreements that allowed those assets to be carried at book value rather than market value.

The difference is this: book value is for savers.? Just take their deposit, and credit interest to them.? No volatility.? That’s the beauty of stable value; it seemingly eliminates the volatility of the markets, and lets savers be savers.

But what is going on under the hood?? Many AAA asset classes have done poorly in the recent past, and I am not talking about CDOs.

Stable value funds have an average maturity of around 2 years.? If I look at AAA asset-backed, commercial mortgage-backed, or corporate securities in the 2-year maturity bucket, I see dollar prices that average around $90.? Stable value funds may have $90 of assets at current market value backing $100 of book value.

This is not a stable situation, no joke intended.? If I were in this situation, I would move all of my money to the most stable option in my DC plan that I could, because of the possibility of a run on the fund.? Now, if few withdraw on net, after 2-3 years, this situation will likely resolve itself.

But who can rely on the intelligence of other fundholders?? This is like the prisoner’s dilemma, where he can act and get something, harming others in the process, or get harmed himself.? Consider your own needs here; my own view is that we will see failures of stable value funds within 2009.

11 thoughts on “Unstable Value Funds? (III)”

  1. It is amazing how little has been written on this. As usual you are ahead of the curve and providing thoughtful original commentary instead of the slapdash stuff on many investment sites.

  2. This is an interesting problem that is likely not reaching a head at present for an incredibly ironic reason. Many plan participants are currently fleeing “risky” funds seeking cover in “safe” options like the stable value funds. Many of the plans I see have this as their only “money market” equivalent and often just one other fixed income fund, such as Pimco Total Return. This raises two big issues. First, is a bond fund better given the chances of higher interest rates and losses potentially the same or higher than even an impaired stable value fund? Second, what will the litigation aspects be once trustees of these ERISA plans are sued for not offering a truly safe US Treasury only money market fund?

  3. James,

    You have described my 401(k) perfectly: a stable “fixed fund” and Pimco Total Return. The rest are equity funds.

    Every time David posts one of these articles, it makes me nervous.

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  5. David, this is an excellent (and scary) post. The dilemma actually seems worse than you suggest. For most people with a DC plan the only ?conservative? option besides a stable value/GIC fund is often a MM fund. After last year, people are more aware that MM funds can break the buck. It?s extremely hard to find out the actual investments in a DC plan stable value fund, and most people wouldn?t know how to evaluate them even if they knew how they were invested.

    So which is the ?most stable option?? Is it the stable value fund that might break the buck, or the MM fund that might break the buck? The Treasury guarantee fund only protects MM funds up to the amount that one held as of last September 19th, so that’s no help for people who’ve been using the SV fund as their conservative option.

  6. David, Very good article. I am consulting in this area. Hueler has the latest market to book and based on what I heard on those numbers, I am guessing over half the plans are under 97 m/b.
    2 weeks ago I published a more technical article on stable value. Send me your e-mail if you want to see it.

    Chris Tobe, CFA, CAIA
    Breidenbach Capital Consulting
    502-648-1303

  8. Should people start hiding their cash in their sockdrawers or under their beds??? All of my 401k is in a stable value fund and it is the only investment isn’t going down on the monthly basis. I guess a 10% haircut isn’t too bad.

  9. James Dailey – post 2: Your final thought has been my plan for a year. Our extremely limited 401k choices are with Fidelity (via our employer), and their MIP II stable value fund is where we have been forced to park our “cash” to avoid the average 50% – 60% losses in the other fund options. Last year instead of a net loss, we had a gain of 4%. Nothing to cheer about when we know how risky the MIP II may prove–the one paragraph description we are given instead of a prospectus is the scariest one paragraph you might ever read. So we have been lobbying our benefits department to add Fidelity’s short term treasury fund, or at the very least an ultra conservative money market fund to our plan for nearly a year now. (Including requests to let us transfer the account OUT to a 401k with an unrestricted brokerage, which would be the ideal option.) All correspondence has been via email just to keep a written trail. If the Fidelity MIP II ever costs us a penny, there WILL be a lawsuit. Period.

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