Stable-Value Strategies Becoming Riskier

WASHINGTON - NOVEMBER 23:  Members of the news...
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After all fees are deducted your ‘stable value fund’ might show negative returns if circumstances change. Care must be taken when employment structure changes.

While stable value investment strategies have performed relatively well during the past few years compared to money market strategies, we believe the changed environment means investors should revisit these with a view to understanding all the risks now associated with this investment strategy,” said Peter Schmit, research manager in Towers Watson’s investment business and coauthor of the paper. “Regardless of upcoming regulatory decisions, we believe there has been a structural shift in competitive advantage away from plan sponsors and stable-value managers over to insurance providers and the investment strategy now faces distinct market risks and regulatory headwinds.”According to the research, stable value has long been a popular investment option in defined contribution (DC) plans, as plan participants have appreciated the principal preservation, benefit responsiveness, liquidity and consistently higher returns compared with money market options, with a similar risk profile.

However, Towers Watson notes that plan sponsors should be aware of the type of events that may trigger a violation of the wrap agreements and cause a potential market-value adjustment, such as a workforce reduction or the addition of a competing fund option (money market or self-directed brokerage option) within the DC plan.

Such risks include counterparty, term, credit and liquidity (at the plan level) and are exacerbated by:

  • Complexity
  • Lack of standardization
  • Less-than-ideal transparency
  • Changing markets prompted by uncertainty over Dodd-Frank, swap legislation, diminishing capacity and evolution of the wrap market
  • The reality of higher wrap fees and lower yields

There is no such thing as risk free.

Please comment or call to discuss how this could affect your company retirement plan.

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Court Rules Kraft’s 401(k) Plan May Have Holes

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Plan sposnors as well as plan participants must understand that their 401k plan is a retirement savings vehicle and not a venue to speculate. When planning for retirement we must address two components, expected return AND expected risk.

The plaintiffs are participants in Kraft’s defined contribution plan, which had assets ranging from $1.5 billion to $5.4 billion between 1994 and 2010. They brought a class action alleging that Kraft and others breached their fiduciary duty by including two actively managed funds, a Growth Equity Fundand a Balanced Fund, among the investment options available to plan participants.The consultants to the plan only considered funds with a minimum seven year track record, with at least $500 million under management. They focused on the past returns of the funds selected, which were the primary determinant.

This focus on past performance is typical of the way actively managed funds are selected, even though (as everyone except consultants to benefit plans is aware) past performance is not predictive of future performance. One study looked at hiring and firing decisions by 3,700 plan sponsors (public and corporate pension plan, unions, foundations and endowments) over a 10 year period from 1994 to 2003. Three years prior to hiring, the fund managers selected all had stellar records of beating their benchmarks. Post hiring excess returns were zero or less.

This case is an excellent representation of how retirement plans are sold to many plan sponsors. I have taled with many advisers who boast of their “26 point check list” when screening mutual funds. These screenings are for the most part worthless.

Please comment or call to discuss how this affects you and your compoany plan.

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Why Fees Matter for 401(k) Plan Fiduciaries, But Not Defined Benefit Pension Plans

401(k) Fee HELP Hearing Mitchem
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Defined Benefit: Plan Sponsor Bears Risks

Plan sponsors more or less guarantee a predetermined benefit to participants in traditional pension plans. This is why they’re called defined benefit (DB) plans. Whether plan sponsors spend wisely or foolishly on their plans, the sponsors are still on the hook for paying the agreed-upon pensions to their retirees.

For example, let’s say a plan sponsor invests in a global index fund with an expense ratio of 2% instead of 1%. The additional 1% in expenses has no direct impact on plan participants’ retirement income because participants’ benefits are set independently of investment returns. Also, the extra 1% in expenses comes out of the plan sponsor’s pockets, not the plan participants’. Pensions’ investment portfolio assets belong to corporations, not employees. This contrasts with the situation for defined contribution plans.

Defined Contribution: Plan Sponsors “Off the Hook” for Benefit Level

Plan sponsors make no promises about the level of benefits that participants in defined contribution plans will receive. In fact, the only thing participants know for sure is what is contributed into their defined contribution (DC) plan. The plan sponsor isn’t even required to contribute to participants’ retirement. Moreover, in contrast to the DB situation, the assets in the DC plans don’t belong to the corporation. They are held in trust for the benefit of the participants and their beneficiaries.

Here’s why plan expenses matter in 401(k) plans: The level of portfolio returns will affect the participants’ retirement income. Expenses—along with contributions and investment performance—are an important factor in long-term returns. Plan participants bear all of the risk if their portfolios don’t return enough to provide the retirement income they anticipated.

Higher expenses mean lower returns. This is why DOL sets high standards for DC plan sponsors’ expenses, yet pays little attention to expenses of their DB peers.

Plan sponsors maintain the responsibility to monitor plan expenses. The new fee disclosure regulations will show employees that they the employees are paying all or most of the fees associated with their plan. Questions will begin soon after the regulations take affect January 1, 2012.

Please comment or call to discuss how you will be affected.

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