CALLAN

INVESTMENTS
INSTITUTE

March 2016

Research

The Renaissance of Stable Value

Capital Preservation in Defined Contribution

Stable value funds are low-risk investment options in participant-directed plans that mix capital preservation with return generation. They invest in high-quality, short- and intermediate-duration fixed
income securities, and utilize wrap contracts to insulate individual plan participants from market value
fluctuations.
Stable value funds serve as an alternative to more volatile or risky asset classes and are a direct substitute for a money market fund. They typically offer a more attractive yield than money market funds,
except during periods when short-term rates are rising rapidly.
This paper describes how the underlying mix of securities and issuer characteristics have evolved
since the financial crisis, and why Callan sees stable value as a healthy and important part of the U.S.
retirement plan marketplace.

Introduction
In this paper, we seek to answer questions defined contribution (DC) plan sponsors and their participants may have about stable value funds, including mechanics, instruments, liquidity, and implementation considerations. We also look at risk and performance, address benchmarking issues,
cover recent trends, and provide key takeaways for DC plan sponsors. Stable value funds are
popular with DC plans and 529 college saving investors. According to Callans DC Index, 65% of
DC plans offer a stable value fund, and typically 14% of total plan assets are in such funds when offered. We believe stable value can be an effective investment option for DC plan participants
seeking capital preservation.

Knowledge. Experience. Integrity.

Mechanics: How Does Stable Value Work?

Stable value portfolio managers invest in high-quality, short- and intermediate-duration fixed income securities. Their portfolios include Treasuries, U.S. agencies, agency mortgage-backed securities, corporate bonds, asset-backed securities, and commercial mortgage-backed securities. Wrap contracts issued
by financial institutions (generally insurance companies and banks) insulate individual plan participants
from market value fluctuations arising from interest rate changes
Wrap Contracts
Help minimize the impact
of interest rate fluctuations
and smooth payments
over time.

while providing steady income. In turn, the wrap providers negotiate

investment guidelines for the stable value portfolio, including the
investable universe of securities based upon quality and sector constraints. Wrap providers typically require overall portfolio duration
(interest rate sensitivity) to remain between two and four years in
order to control price volatility, which is the risk they seek to control.
Capital preservation is achieved through a stable fund net asset
value (NAV) set to $1. Income from the fund is provided via a crediting rate that resets periodically as market value gains or losses are
amortized over time. The crediting rate is calculated based upon
the market value, book value, yield-to-maturity, and duration of the
underlying assets. This crediting rate will fluctuate based upon the
performance of the underlying portfolio. Assets not covered by a
wrap contract are usually held in short-term money market instruments, and are used to meet participants cash flow needs. Most
importantly, these contracts allow for daily participant cash flows
to non-competing options at book value, regardless of the market

Competing vs.
Non-Competing Options
Participant-driven cash flows
out of stable value funds are
unlimited, with the exception
of transfers to competing options. Such options typically
include money market funds
or short-duration bond funds,
but may include TIPS funds
or a brokerage window. Participant flows may be limited
by an equity wash provision
which requires transferring
assets to reside in a noncompeting option for a period of up to 90 days.

value of the underlying portfolio. While unlikely, it is possible for a

stable value fund to lose value. However, the financial institutions issuing wrap coverage to stable value
funds require conservative management practices, and thus the likelihood of such a loss is slim.
Wrap Contracts
Four types of wrap contracts are used by stable value funds. Most stable value funds utilize a mix of
two or more in an effort to diversify coverage and costs. All four categories meet the needs of stable
value funds, but market dynamics at the issuer level often dictate the types of contracts being offered
at any given time.
1. Traditional Guaranteed Investment Contract (GIC): A group annuity contract that guarantees a
fixed rate of return over a specified period of time.
2. Insurance Company Separate Account GIC: A customized group annuity contract that pays a
periodically adjusted rate of return, or crediting rate. The crediting rate reflects the performance
of the underlying assets outside of the issuers general account. The insurance companys general
account backs any unpaid obligations of the separate account, if necessary, but generally all liabilities are met by the separate account assets. Separate account assets may not be used by the
issuer to satisfy general account liabilities. These contracts tend to be evergreen in nature, with
no finite maturity.

3. Fixed Maturity Synthetic GIC: A combination of an underlying fixed income portfolio within a book value wrap

Duration
A measure of an
investments sensitivity to
changes in interest rates.

Lapse in Wrap Coverage

contract, usually issued by an insurance company, bank,

Sponsor-driven events, such as a

or other financial institution. The contract issuer provides

merger, layoff, bankruptcy, or re-

book value accounting for any cash flows, provided all un-

vised early retirement program,

derlying assets are held to a maturity date as specified in

may result in the loss of wrap cover-

the contract. The crediting rate is generally reset quarterly.

age. Plan sponsors should discuss

Also known as a buy and hold synthetic GIC.

such events directly with the stable

4. Constant Duration Synthetic GIC: A combination of an

value fund provider as soon as pos-

underlying actively managed fixed income portfolio within

sible, as coverage can generally be

a book value wrap contract, usually issued by an insur-

negotiated to ensure the ability of

ance company, bank, or other financial institution. The is-

participants to continue to transact

suer provides book value accounting for any cash flows,

at book value.

provided all contract terms and investment guidelines are

met. The underlying portfolio is constantly reinvested to maintain a target duration within a predetermined range, and a new crediting rate is generally calculated quarterly. Also knows as managed or
evergreen synthetic GIC.

Implementation
Vehicle Options
Stable value funds are only available in separate account and commingled fund structures.1
Separate accounts offer larger plans (over

Commingled funds offer an off-the-shelf solu-

$75mm in stable value assets) greater input into

tion for small and mid-size plans, but do so with

investment guidelines, sub-advisor selection, and

no customization, little negotiating power from the

wrap structure. Wrap providers, in turn, may pre-

plans perspective, and slightly higher fee levels.

fer to underwrite separate accounts as they can

Additionally, participants may be impacted by

receive far greater clarity regarding participant

cash flow activity from the other plans invested

demographics and transaction behavior. As a re-

in the fund. One advantage versus a separate

sult, separate accounts often offer greater wrap

account structure is that a plan sponsor will not

stability when compared to commingled funds. As

see a potential lapse in wrap coverage due to a

another benefit, plans with a capable stable value

sponsor-driven event. Most commingled options

separate account manager have more negotiat-

are created with a mix of multiple wrap providers,

ing power with regard to sponsor-driven events,

wrap types, and often multiple underlying portfolio

competing-option classification, and put-provision

managers. Many insurance companies also offer

implementation. While separate accounts may

general account stable value options, where the

take more time to initially establish, they often

sponsoring insurance company is the sole insurer

offer a fee advantage, resulting in stronger long-

of the fund. Such options tend to be offered exclu-

term performance.

sively through an affiliated recordkeeping platform.

1 For an overview of investment vehicles, please see Callans charticle, The Investment Vehicle Owners Manual, available at
www.callan.com.

Knowledge. Experience. Integrity.

Return, Risk, and Cost

The funds in Callans Stable Value Database group have exhibited similar returns to limited duration strategies, such as the Barclays 13 Year Government/Credit Index, with risk similar to cash investments, over a
recent 10-year period (Exhibit 1).
The use of wrap contracts by stable value funds results in markedly greater return consistency than
money market funds, as can be seen against the 3-Month T-Bill Index in Exhibit 2. Stable value funds

Exhibit 1
Risk vs. Return:
Stable Value Managers
vs. Benchmarks

5%

10 years ended
December 31, 2015

4%

Individual managers in Callans Stable Value database

Barclays Aggregate
Barclays Government/
Credit Intermediate
Callan Stable Value
Database (median)
Barclays Government/
Credit 13 Year
Barclays Treasury 13 Year

Return

3%

2%

3-Month Treasury
1%

0%
0%

1%

2%

Source: Callan

Exhibit 2

Rolling 1-Year Returns

15 years ended
December 31, 2015

Callan Stable Value Database

4%

5%

3-Month Treasury

Barclays Government/Credit 1-5 Year

12%
10%
8%
Total Return

Return Consistency:
Stable Value Managers
and Indices

3%
Risk

6%
4%
2%
0%
-2%
01

Source: Callan

02

03

04

05

06

07

08
Year

09

10

11

12

13

14

15

have underperformed money market funds in the past, but historically only for a very short period of
time. Similarly, the stable value group exhibits far less return volatility when compared to a benchmark
with a similar duration, such as the Barclays 15 Year Government/Credit Index.
Crediting Rate
A periodically adjusted
rate similar to an effective
annual yield.

Stable value funds issue investors a periodic return known as a crediting rate. This rate, which is published as an effective annual yield figure, is usually credited to the stable value fund on an ongoing basis.
The crediting rate is similar to the interest earned on a money market fund and is based upon the market
value, book value, yield-to-maturity, and duration of the underlying assets. The calculation is designed to
amortize the difference between the book value (purchase price) and the market value (current price) of
the underlying portfolio over time. Crediting rates are directly related to the interest rate environment, and
thus it is not surprising to see a downward trend over the last seven years (Exhibit 3). However, stable
value funds continue to offer a substantial yield advantage versus money market funds.

Exhibit 3

Median crediting rate

Median Crediting Rates

5%

Seven years ended

December 31, 2015

4%

10th to 90th percentile crediting rate

3%

2%

1%

0%
2009

2010

2011

2012

2013

2014

2015

Source: Callan

Market-to-Book Ratio
Market-to-book ratio is simply the ratio of the market value of the underlying assets to the book value of
the stable value portfolio. It is commonly used to measure the overall health of a stable value portfolio,
and the degree to which the portfolio has a market value shortfall (or insufficient funds to meet participant investments). It is not uncommon for a stable value fund to have a market-to-book ratio below
100% for a short period of time due to market value fluctuations. Stable value funds experiencing such
valuations should be closely monitored, as the portfolio manager must explain and defend any market
value fluctuations that result in a deficiency. Stable value funds that do not experience positive ratio
improvement over time require further investigation.

Knowledge. Experience. Integrity.

Comparing Stable Value Benchmarks

Measuring stable value performance can prove challenging, as there is not a perfect benchmark solution
that represents a stable investment option. Available options include cash or money market benchmarks, broad market benchmarks, and peer group comparisons. These options each have pros and cons,
and Callan recommends a combination of benchmarks to address the individual options shortcomings.

The stable value

industry has widely
accepted the 3-Month
Treasury bill as a
benchmark.

1. Cash or money market benchmarks have a similar risk profile but different return profile than
stable value funds as their underlying investments are very different. The stable value industry
has widely accepted the 3-Month Treasury bill as a benchmark. DOL rule 404(a)(5)2 mandated the
use of an appropriate, broad-based securities market index for investment strategies, and
the 3-Month Treasury Bill Index meets this standard. As such, the majority of commingled stable
value fund fact sheets have selected this index. Cash/money market benchmarks are defensible as
they represent the return a participant is forgoing by investing in stable value rather than a money
market fund. In addition to the 3-Month Treasury Index, Lipper and iMoneyNet offer money market
index options.
Pros

Cons

Risk level is expected to be very similar

Underlying investments are different

The 3-Month Treasury benchmark is trans-

Return mismatch can be extreme (particu-

parent, investable, and known in advance

larly in a low interest rate environment)

Cash-based indices are popular when it

comes to participant reporting

Constant maturity Treasury and iMoneyNet/

Lipper benchmarks are not investable

2. Broad market benchmarks are defensible, but they are difficult to utilize because finding a perfect
match for stable value is difficult. Broad market, fixed income benchmarks experience market value
fluctuation, and thus these benchmarks do not reflect the impact of wrap contracts. Additionally, most
have quality and sector characteristics vastly divergent from stable value funds. Investors have considered the Barclays Intermediate Aggregate or Barclays Intermediate Government/Credit Indices
as potential options. However, the Barclays Intermediate Aggregate includes too much MBS/CMBS
exposure (35%), and the Barclays Intermediate Government/Credit includes too much credit (35%).3
Barclays developed the Stable Income Market Index (SIMI) in 2010 as a potential benchmark for the
stable value market. It was designed to mimic the shorter-maturity, higher-quality profile of stable value
portfolios. However, it too lacks book value/amortized cost basis and often differs from existing funds
on a sector allocation basis. Market acceptance of this index has been minimal, in our observation.

2 United States. Department of Labor. Employee Benefits Security Administration. (2012). Fiduciary Requirements for Disclosure in
Participant-Directed Individual Account Plans (Section 2550.404a-5).
3 For a comprehensive look at fixed income indices, please see Callans annual Fixed Income Benchmark Review, available at
www.callan.com.

Stable value managers may create custom blends of off-the-shelf Barclays benchmarks, such as a
blend of 50% Barclays 13 Year Government/Credit, 35% Barclays Intermediate Government/Credit,
and 15% Barclays 3-Month Treasury. However, such blends suffer from inconsistency versus the
underlying security makeup of a stable value fund for benchmarking purposes, and again have no
correction for the impact of wrap contracts.
Pros

Cons

Broad market benchmarks are widely avail-

Lack of book-value wrap coverage/amor-

able, investable, defensible, and transparent

tized-cost adjustments
Volatility may be much higher, leading to a
risk mismatch and participant confusion
Most off-the-shelf indices offer a quality or
sector mismatch

3. Peer group comparisons offer another solution. However, they are not truly investable in that one
cannot buy the median performance. Callan recommends comparing performance versus the Callan
Stable Value Database group, as it includes the majority of institutionally viable stable value strategies.
Pros

Cons

Compares fund performance against other

Peer groups lack true investability, as

publicly available stable value funds

one cannot directly invest in the median

Can be difficult to implement for participant
reporting purposes

Because no single benchmark provides an ideal solution, Callan recommends a combination of a cash/
money market benchmark (e.g., 3-Month Treasury bill) and a peer group comparison (e.g., the Callan
Stable Value Database group) to evaluate performance. A cash/money market benchmark should be used
for participant reporting purposes. This will allow the plan sponsor to evaluate its stable value option versus peers while participants will be able to gauge performance versus a typical money market alternative.

Recent Stable Value Trends

Most of the commingled
vehicles that had been
closed to new assets
for several years have
been reopened.

The 2008 market crisis shook the capital markets, creating unforeseen consequences across asset
classes. Stable value was no exception, with most funds facing an increase in wrap fees, wrap providers
exiting the market, duration limits, and credit rating constraints that were previously rare. In 2013, the
marketplace witnessed yet another year of metamorphosis, as several new wrap providers entered the
marketplace improving overall capacity. Most of the commingled vehicles that had been closed to new assets for several years were reopened. Increased competition from new entrants to the wrap marketplace
has stabilized fees in the range of 2226 basis points, and also improved investment guideline flexibility.
The persistent low interest rate environment has resulted in a widespread decline in crediting rates.
However, stable value continues to offer a positive yield premium over money market funds. Callan
continues to believe stable value is an attractive alternative for eligible investors seeking a capital preservation option.

Knowledge. Experience. Integrity.

Nonetheless, investors should be aware of issues that influence stable value prices and availability.
1. Current rate environment: Interest rates remain historically low, directly impacting crediting rates.
Stable value funds continue to offer a substantial yield premium over money market funds, which
are subject to regulations specifying investment in very short-dated securities. If interest rates were
to rise sharply over a short period of time, investors could experience a period during which money
market funds out-yield their stable value alternatives. Such periods have historically been very short.
2. Uncertain regulatory environment: As part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) were tasked with determining if stable value wrap contracts should be considered
swap agreements and thus fall under CFTC regulation. To date, no decision has been made. All signs
have pointed to the CFTC and SEC ultimately deciding against the regulation of wrap contracts, but this
is still to be determined. Current contracts will not be impacted, regardless of the final decision.
3. Commingled funds are open for business: After the 2008 credit crisis, numerous banks and other
financial institutions exited the wrap marketplace. This forced many stable value commingled funds
to close to new investors, due to their inability to obtain additional wrap coverage. New entrants to
the wrap marketplace, in particular insurance companies, have vastly improved this dynamic. At this
point, all of the pooled funds tracked by Callan are again accepting new deposits.
Wrap Market and Fees
With the exit of numerous wrap providers post-2008, wrap fees rose substantially (Exhibit 4). In our observation, new wrap issuance falls in the 2530 basis point range, much higher than the 810 basis point
range seen in 2008. The recent increase in competition in the form of new entrants into the wrap space
has resulted in overall wrap fees paid by most funds stabilizing in the 2225 basis point range. In particular, insurance companies have become very competitive with their wrap coverage pricing.
The addition of new entrants into the space appears to have slowed the increase in fees, and anecdotal
evidence points to a general willingness to negotiate both guideline restrictions and various expenses.
Separate accounts continue to have far greater success in obtaining attractive wrap coverage.
Exhibit 4

Median wrap fee (bps)

Median Wrap Fees

30

Seven years ended

December 31, 2015

25

10th to 90th percentile wrap fee (bps)

23.0 bps
22.0 bps
20

19.0 bps

15

10

5
2009
Source: Callan

2010

2011

2012

2013

2014

2015

Highlights of Recent Trends

Commingled funds reopen: With the recent influx of insurance companies offering wrap coverage, numerous commingled funds that were previously closed have reopened to new investors. Some providers extended put provisions from one to two years, but the majority of the market retained a one-year,
put-provision time frame.
Duration has dipped slightly: After stable value funds experienced volatility in 2008, wrap providers
pushed for tighter guidelines. Duration has typically been capped at a maximum of three years, often
as low as two-and-a-half years. Wrap providers currently have a keen eye set on minimizing interestrate risk, and thus duration caps are common.
Market-to-book ratios have improved: Market-to-book ratio, which measures the overall health of a stable
value fund, plummeted during the financial crisis. As the fixed income market recovered, so did market-tobook ratios. For the last three years, Callan has only observed one single stable value commingled fund
within our database with a market-to-book deficit. The median market-to-book ratio was 100.56% as of
December 31, 2015 (Exhibit 5).
Crediting rates dipped to historic lows: The current interest rate environment pushed the median crediting rate to just over 1.50% in mid-2014, but it climbed slightly to 1.78% as of December 31, 2015. Tighter investment guidelines, as negotiated by wrap providers, have also had an impact on crediting rates.
Callan anticipates these rates will remain range-bound in the 1.50%2.00% space in the near term.
Fee disclosure has improved, but issues remain: Stable value funds have vastly improved fee disclosure in recent years, and wrap fees are now fully disclosed by most funds. However, the lack of fee
transparency in traditional GICs artificially lowers the published wrap fees of those stable value funds
that utilize them extensively. Additionally, insurance companies that offer stable value products backed
by their general accounts tend to publish fees that are not fully transparent.

Exhibit 5
Median Market-to-Book
Ratio
Seven years ended
December 31, 2015

10th to 90th percentile market-to-book ratio

Median market-to-book ratio

110%

105%

100%

95%

90%

2009

2010

2011

2012

2013

2014

2015

Source: Callan

Knowledge. Experience. Integrity.

Conclusion
When DC plan sponsors are selecting a capital preservation vehicle, stable value funds remain an
Insulation from market
value volatility due to
interest rate movements
is exactly why stable
value funds are so
popular as a capital
preservation option.

attractive alternative to money market funds. Their historical yield advantage, coupled with consistent
book-value accounting, results in an investment that is well suited for the risk-averse investor. While
we are in a period of interest rate uncertainty, investors should expect market-value-to-book-value
ratios to decline in a rising interest rate environment. It would not be surprising to see a period where
the market-to-book ratios across stable value strategies remained below 100% for a period of time.
Nevertheless, investors should not be concerned about a broad-based decline in market-to-book ratios
resulting from a rising interest rate environment. Insulation from declining market values due to interest
rate volatility is exactly why stable value funds are so popular. Additionally, a rising rate environment
will ultimately allow stable value managers to reinvest in securities with higher coupon payments, and
thus should benefit investors through higher crediting rates over time. Callan continues to believe that
stable value is a strong investment option for a well-rounded DC plan.

Key Facts about Stable Value Funds: A Summary

Stable value funds are a capital preservation investment option within qualified DC and tuition
savings plans. They are expected to function as a low-risk investment vehicle that offers a
better return relative to traditional money market funds while exhibiting less volatility than most
bond funds.
By mixing traditional fixed income securities and insurance contracts along with book value wrap
contracts, stable value funds can offer principal protection.
Issued by insurance companies and other financial institutions, book value wrap contracts are
used to minimize the effects of market value fluctuation due to changes in interest rates.
A crediting-rate formula based upon amortization of market gains and losses on underlying
bonds determines quarterly returns for many funds.
Traditionally, stable value has offered a return premium over money market funds, as stable
value managers have the ability to invest in securities with maturities longer than 90 days.

10

About the Author

Steven J. Center, CFA, Steven J. Center, CFA, is a Senior Vice President in Callans
San Francisco Fund Sponsor Consulting office. His responsibilities include client service,
investment manager reviews, performance evaluation, research and continuing education, business development, and coordinating special client proposals and requests.
Steve joined Callan in 2010 as a Vice President and fixed income investment consultant
in Callans Global Manager Research group. Steve is a member of Callans Manager Search Committee
and a shareholder of the firm.
Prior to joining Callan in 2010, Steve held positions at Wurts & Associates, Alan Biller & Associates, and
Wilshire Associates.
Steve earned an MBA with Honors from the Michael G. Foster School of Business at the University of
Washington and a BA in Economics from the University of California, Irvine. Steve has earned the right
to use the Chartered Financial Analyst designation and is a member of CFA Institute and the CFA Society
of Seattle.

If you have any questions or comments, please email institute@callan.com.

About Callan
Callan was founded as an employee-owned investment consulting firm in 1973. Ever since, we have
empowered institutional clients with creative, customized investment solutions that are uniquely backed
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pension plan sponsors, endowments, foundations, operating funds, smaller investment consulting firms,
investment managers, and financial intermediaries. For more information, please visit www.callan.com.
About the Callan Investments Institute
The Callan Investments Institute, established in 1980, is a source of continuing education for those in
the institutional investment community. The Institute conducts conferences and workshops and provides
published research, surveys, and newsletters. The Institute strives to present the most timely and relevant
research and education available so our clients and our associates stay abreast of important trends in the
investments industry.
2016 Callan Associates Inc.
Certain information herein has been compiled by Callan and is based on information provided by a variety of sources believed to
be reliable for which Callan has not necessarily verified the accuracy or completeness of or updated. This report is for informational
purposes only and should not be construed as legal or tax advice on any matter. Any investment decision you make on the basis of
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11

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