Sue Lee: Welcome to Asset TV. I'm Susanna Lee. A volatile 2018 has many risk-averse investors looking for cover. So for those who don't want to ride a stock market's rollercoaster, are stable value funds the way to go? Found only within defined contribution plans, these funds are an option for preserving capital and income seekers. Joining us now in all the details of stable value funds are Andy Apostol, the head of stable value client service at Invesco. Also with us is Warren Howe, the national director stable value markets at MetLife. Great to see both of you here. Thank you for joining us today.

Andy Apostol: Thank you.

Warren Howe: Thanks for having me.

Sue Lee: Andy, let's start with you. Investor sentiment has changed in 2018, from much more risk on 2017. How has the market volatility impacted stable value investing?

Andy Apostol: Sure. Equity markets experienced a significant amount of volatility, especially in the fourth quarter, with a negative return in October, and a significantly negative return in December, so really brought the equity markets to an all-time low over the last 10 years. It's a rare occurrence that stable value is one of the top performing asset classes relative to both equities and core bonds.

Sue Lee: Warren, give us an overview on what you consider the advantages of stable value funds, and what are the risks associated with stable value funds?

Warren Howe: Sure. Stable value has a lot of advantages, and it's always a good idea to have a stable value option in your defined contribution plan, especially when you think about plan sponsors who need to have a capital preservation option in the lineup. Typically, it's either going to be stable value, a short-term bond fund or money market funds. When you look at the three of those, stable value is clearly the superior alternative in that case. As Andy was talking about when we looked at the volatility in the market late last year, that's the key thing there when you think about a stable value fund. What does it provide? It provides a safe haven, capital preservation, and a reasonable return for participants. It gives people that safe haven for investing when they see the equity markets experiencing 700 point up and down in any given time period. A place to go to put those dollars to preserve their wealth for retirement.

Sue Lee: Can you please elaborate your thoughts on stable value's market performance history, especially in light of the long-running bull market, which has been a headwind for this asset class?

Andy Apostol: Sure. Stable value has met all of its objectives, providing positive returns on a daily basis over its inception. Strong equity market performance has resulted in significant transfers out of the stable value asset class. While stable value funds have been in gain positions, the negative cash flows have not been problematic. They've actually helped to bolster the crediting rates. Now that we're interest rates have caused stable value funds to move into a deficit position, negative cash flows will have a significant headwind in terms of keeping the crediting rate tracking market interest rates.

Warren Howe: What you tend to see is participant behavior. I always find it interesting to look at participants and how do they act. You talk about market timing, and people's ability to do that. When you see a long bull market in equities, people forget about risk. They think that it's always gonna continue to go up. The new dollars chase the equity markets. The transfer dollars, as Andy said, chase those markets. People forget about risk a little. But then, as you said before, when you bring that volatility back in, and people understand that there actually is risk, that's when you see those trends reverse and the dollars start to flow out of the equity markets and back into stable value.

Sue Lee: Right. So what about in a rising interest rate? What does that

mean for stable value investors?

Warren Howe: Well, it's interesting, because there's always been the perception that stable value works great in a declining interest rate environment, but could experience a little bit of a difficult in a rising interest rate. Andy, I don't know about you, but I would say that's not necessarily the case. When you look at stable value, as you said, it's designed specifically for the defined contribution market. Part of that is it's designed to perform in all interest rate scenarios, whether that be a declining interest rate scenario, whether it be a prolonged flat interest rate scenario, or a rising rate scenario. What it's going to do is it's gonna lag the market, so on the way down stable value yields will lag the market based on the crediting rate reset formula in place to provide that volatility smoothing, and on the way up it will lag a bit as well, but it will track the general direction of interest rates over time.

Sue Lee: So it's a lagging indicator?

Warren HoweIt's a little bit of a lag based on the crediting rate formula, and how it applies that to smooth out that volatility so that you don't have those periods where you have a gain and then a loss, and a negative return. It's smoothing that out for you so the ride is a little bit easier.

Sue Lee: Andy, how has the rise in interest rates impacted financial positioning, especially the book to market value ratios of stable value portfolios?

Andy Apostol: Sure. We've done a significant amount of education with consultants and plan sponsors on the topic of rising market interest rates. We started that in an environment when stable value funds were in the gain or surplus position, figuring we'd have more credibility with our comments in terms of plan sponsor just education, letting them know, as Warren pointed out, stable value works in identical fashion in a rising and falling interest rate environment. The uptick in market interest rates that we've seen over the last couple years has been beneficial to stable value, so that's point number one as to identify that higher rates are better for stable value investors. If we look at our just general level of crediting rates, they're up about 70 basis points over the last couple of years. Direct benefit to those investors.

Andy Apostol: But the flip side, higher interest rates and bond prices are inversely related. Rising rates have had an adverse impact on bond prices, which put our funds, and all stable value funds, not just the Invesco stable value funds, in a slight deficit position. Depending on the magnitude of interest rate changes, financial position, it could be anywhere from 98 to 99% of the market to book value ratio.

Warren Howe: It's interesting, because there's always the question as well about market to book ratios, and how cognizant of that should a plan sponsor be, or should a participant be. I think I would say that they should be cognizant of what the market to book ratios of a given fund are, but understanding to Andy's point that across the industry they're all gonna be in a fairly tight band. If there's a fund that is aberrant in terms of the market to book, either when things are negative or when it's positive, maybe a need for a closer look. But if you look at it, stable value is designed exactly for negative market to book scenarios and positive market to book scenarios. Again, it smooths out that volatility in between. Participants and plan sponsors shouldn't get too hung up on a negative market to book at any given time.

Sue Lee: But should stable value investors be concerned with market value to book value ratios below 100%?

Warren Howe: I would say that they shouldn't be overly concerned. I think it's one indicator of a fund, but if you look across, it's more the comparison of how that stacks up to other funds. The beauty of stable value is for participants, when they transact within the plan. So if they're taking a withdrawal, if they're taking ... They're transferring to another option, they're retiring. That's all done at the book value, and that's the beauty of stable value. It's giving you the book value return even if the market value of the assets are below book value. So from their perspective, that's when it's doing exactly what it should be doing.

Andy Apostol: Just for context, market to book value, if we had to identify a typical range, would be 97% to 103%. We would expect that, barring any radical changes in market rates or spreads, to be what we would consider a normal range for market to book value ratios. Given the trajectory if you look at interest rates over the last 20 years, they've been on a secular decline. That has by default meant that stable value funds have been in that surplus position for an extremely long time, so at 100% or in a slight surplus position. That's one of the issues that we're now contending with is we've always communicated that higher rates will provide lower market to book value ratios. That has come to fruition. I'd say my clients, the consultants I work with, the plan participants, haven't ... I think the education that we've done has worked. I haven't had anybody express alarm over the level of market to book value ratio, yet, as Warren said, it is something that consultants and plan sponsors are keeping their eye on.

Warren Howe: It's key. As you educate plan sponsors and participants more about the way stable value is intended to operate, and what these normal ranges are, and that it's perfectly fine for it to go call it a 97, or to be at a 103. That's exactly the sweet spot of where it's going to move. So from a manager's standpoint, from a wrap provider's standpoint, we expect it, we understand it, and that's the important part about having partners in the business who understand what stable value is, and have been in it for a long enough time to experience market to books below par, market to books above par, and how to operate within that.

Sue Lee: Warren, regarding corporate bonds, what is it that you're looking in that universe?

Warren Howe: Well, Andy can probably address it as a manager a little bit more about corporate bonds, but typically within your stable value funds what you're going to see are a diversified basket of high quality fixed income securities. It'll be treasuries, it'll be corporates, it'll be asset backs and mortgage backs, but a very high grade, high quality portfolio.

Sue Lee: How are you doing your due diligence regarding corporate bonds?

Andy Apostol:  I'd say with every asset class, one of the items to note is stable value guidelines tend to be very, very stringent in terms of allowable investments. We tend to, whether it be corporates, asset backs, mortgage backs, securities, we tend to lean towards the higher quality, more conservative investments in the stable value fund. Tying back to the market to book value ratio, you get spread widening that occurs. You get bond prices that change in response to market interest rates, but they're fixed income securities that have payout dates.

Andy Apostol: So really, any widening that would occur in say the corporate sector, or any other sector, as bonds move towards maturity, they're always moving towards that par payout. So really, the enemy in terms of market to book value ratio, stable value crediting rate, and working with the wrap issuers would be defaulted securities, and really trying to avoid those security defaults, or the bonds that are not money good, or having to sell a bond at a very distressed time in the market. Because that's the value in the portfolio that you really lose, in terms of longterm income potential in the stable value fund.

Warren Howe: Which is where the investment guidelines come into play, right? If you think about stable value is not a total return, shoot for the stars type of return strategy, it is a high quality ... It's capital preservation, first and foremost, with a very competitive interest rate to go along with it. It's not shooting for the stars in terms of return. With that are investment guidelines that go along so that the asset managers understand how they're gonna manage these portfolios, which by nature are a little bit more conservative, but it also helps plan sponsors, and it helps the participants understand how is this portfolio being managed, what is the box within this manager can play to provide the performance to support the stable value fund. Having those guidelines in place helps the manager, helps the asset manager, helps the plan sponsor, and helps the wrap provider understand the risk.

Andy Apostol: I think understanding exactly what the wrap contracts ... The function they're serving in the context of a stable value fund is crucially important. 10 years ago there was probably some ambiguity as to exactly what the wrap contracts were covering. They're providing the participant accounting, the book value accounting. They're not credit derivatives, so they're not providing credit protection against defaulted securities. The credit risk is eventually passed through the underlying stable value investors. The wrap contract isn't guaranteeing the credit performance of all of the underlying securities.

Sue Lee: Warren, you mentioned that expectations for returns, you can't be so aggressive with that when it comes to stable value funds. Andy, can you tell me what you think or compare stable value funds verse money market funds, and what trends you see there?

Andy Apostol: Sure. Historically, stable value funds have produced returns that are roughly 100 to 150 basis points over money market funds. But if we look at the yields on money market funds, and yield on stable value funds from a historical context, the fed easing of monetary policy that happened after the financial crisis really created a decade for money market funds of almost a zero percent return. Late 2008 really up into close to 2016 is the fed began to tighten monetary policy. That difference between earnings on money market funds and stable value funds has driven that difference to historical-wide. Stable value has roughly a 200 to 250 basis point advantage over money market funds.

Andy Apostol: If we look at performance differences over the last 10 years, that equates to roughly a 25% return premium on a money market fund investment. 25% may not, over a 10 year period, may not seem that significant, but when you start putting those into dollars, that would be the difference between earning $75,000 on a money market fund, or $100,000 on your stable value fund. As participants have larger balances, that maybe 375,000 if you were in a money market fund versus 500,000 in a stable value fund. The bigger account balance is, that return difference is much more significant.

Andy Apostol: We also looked at return differences relative to inflation. Stable value funds have the typical risks, credit risks, the crediting rate risk, the lagging, lagging risk of market interest rates. But in terms of interest rate risks, that's often overlooked when you look at a capital preservation option. We actually went back and calculated the net return, so nominal returns less inflation to get an inflation-adjusted returns over the last 10 years. Over that time period, stable value produced a return a little over seven percent.

Andy Apostol: The surprising part of that is money market funds net of inflation produced a return of negative 12% over that same time period. Both stable value funds and money market funds met their objectives in terms of providing participants with positive daily returns. The primary difference is after inflation, you actually lost money on an inflation-adjusted basis in the money market fund, or you actually had a positive gain for stable value.

Warren Howe: 15:06 Yeah, it's interesting because, as we were saying before, that money market is the prime alternative to stable value in terms of capital preservation space, and to Andy's point, prolonged period of zero returns in money market, while stable value was somewhere in the two to two and a half percent range. So when you look at those comparisons, that's a comparison to what would be your prime money market funds. After money market reform in 2016, plan sponsors that are using money market are now in government money market funds. That return likelihood of money market funds themselves is likely to be lower by the nature of being in government-only funds as opposed to the previous prime funds.

Warren Howe: That advantage should persist, but Andy brought up a great point. It's relative to inflation as well. Stable value has been accretive to returns over inflation during this time period, and when you look at money market, it has basically eroded purchasing power over that time for participants. We looked at our block of business over a 10 year period, our stable value business, ending December of '18. During that time, stable value outperformed inflation by about 65 basis points, while money market underperformed by 140. Just within our own block, we're looking at a 205 basis point difference in actual performance between stable value and money market when you take it relative to inflation.

Sue Lee: So what kind of investor would choose a money market over a stable value?

Warren Howe: It's interesting, because typically it's the plan sponsor making the decision. Is it going to be stable value or is it going to be money market? Many times, and Andy I'm sure you see this in your block of business, they will offer both and let participants make the decision. Now there's an equity wash requirement so that participants can't arbitrage return based on where interest rates are, but still many times they'll offer both. What you see is money market is easily understood, it's available outside of retirement plans, everybody knows what it is, and they think of it as safe.

Warren Howe: Sometimes stable value is a little bit more complicated to explain, and one of the things we're both working on is educating plan sponsors about the value. Because with stable value you're getting these increased returns somewhere in the neighborhood of 200 basis points more over time, which is real return for participants, yet you have that advantage, and you have the liquidity that goes with money market for all plan-initiated events. You really don't need the money market option in place, and when plan sponsors understand the difference between stable value and money market, they'll opt for stable value.

Sue Lee: Andy, anything further you'd like to add on stable value funds

verse money market funds?

Andy Apostol: Sure. Echoing what Warren said, we have a handful of clients that offer both money market and stable value funds, and in this instance the plan participants are making those allocations, but in the lion's share of those clients, stable value ... The balance in the stable value fund is typically a magnitude of 10 fold what it would be in the money market fund. Participants are seeing the benefits and the higher returns, and allocating their account balances accordingly.

Sue Lee: Warren, can you tell us now about custom target date funds verse

broad-based target date funds?

Warren Howe: Sure. If you look at target date funds, they're all the rage. They are the most popular investment and defined contribution plans now. I was looking at some ICI data recently, and if you went back to 2008, target date funds were about 158 billion I think the number was. If you fast forward to 2017, target date funds were 1.1 trillion. Just within less than a 10 year period, the significant growth of target date funds is incredible. It's immense. Part of that is by being a qualified default investment alternative where people can default people in with the money. It is the most prevalent option in defined contribution plans at this time.

Warren Howe: So if you're gonna look at that and have target date funds, the future of stable value needs to be incorporated as part of a target date fund. That can go in either of two ways. Either a custom target date fund, or what we call an off the shelf target date fund. The custom target date fund is really the plan sponsor using their existing investment options that they have for their plan participants available that they've done due diligence on, and selected as the best alternatives for their participant base, and using those investment options to create a custom glide path for their demographics of their population, and create target date funds using those. They're using their current investment options as part of the target date, so that's why it's a custom target date.

Warren Howe: When we see those in place, stable value is both a standalone investment option, but also a fixed income component of the target date structure. We've seen an increase in that. I think it's up to somewhere around 15 to 20% of plans now are using a custom target date structure. The advantages being there the plan sponsor has more control. If you're using an off the shelf target date fund, and you don't like one component of the fund, it is, it's a prepackaged model. If you don't like a component of a custom target date fund, you can make a change. You can move out your large cap piece. You can lose out your international equity piece. You can make those changes, plus you can create the custom glide path, instead of just an off the shelf glide path. That's where custom has become popular. I will say this, though. There is a role for stable value in just off the shelf target date funds as well. That's something we're very focused on delivering in 2019 and beyond.

Sue Lee: Demographics-wise, have you noticed any investor demographic that prefers one over the other, or that you would recommend the target versus the custom?

Warren Howe: Well, they're both target date fund structures, so you're gonna have ... It depends on what the plan sponsor makes available. When we say target date, it's the custom target date. It's the off the shelf target date series. You also see things called model portfolios, model risk portfolios. They're all basically the same thing, an acid allocation strategy designed to be done by professionals to get participants where they need to be. Many participants are in target date funds.

Warren Howe: One of the things that I find interesting is I was looking at a study by the Defined Contribution Institutional Association, and they were looking at target date funds and participant understanding of target date funds. They did this in alliance ... In conjunction with AllianceBernstein, and what it found was they had almost 40% of participants thought their target date funds were guaranteed to never lose money. Guaranteed never gonna have a negative return. Almost 40%. Then you look at it, and it was almost 50% that looked at their target date fund, and looked at the terminal date of the target date, and thought that it was guaranteed that if they were in that fund as of that date, they would have sufficient money to meet their retirement needs. It was just guaranteed. The misperception about what target dates do, can do, and should do is prevalent among participants. There's a lot of education that needs to take place.

Andy Apostol: I think custom target date funds are really the natural evolution. When these funds were initially launched, they were mutual funds, collective trust funds. They were in an asset garnering mode, and 10 years ago I don't think anybody anticipated ... Certainly that was the direction the market was heading, but didn't anticipate how quickly they would become the dominant investment in the defined contribution plan. Where we see clients developing custom target date funds, a lot of times that's in conjunction with their consultant. We have a wide range of clients, as does Warren, so you see companies in different types of industries, high tech, old line manufacturing.

Andy Apostol: So when you start thinking about retirement ages, and how that those actually apply to your workforce, each plan has different demographics, so the different age buckets in terms of the overall defined contribution plans. Maybe an off the shelf target date offering would work for a high tech company with generally younger workers that maybe fitting with a typical glide path. You get into some of the old line manufacturing type companies, we're seeing a significant aging of those participants, and that's where it may not necessarily ... An off the shelf product may not necessarily meet those investors' needs. Folks in manufacturing may not be working past their retirement age, where if you're in a professional field, you could be easily working into your 60s and 70s, and still participating in the plan before you go into a draw down mode. We're seeing a lot of focus on the plan participants in terms of developing those custom target date strategies.

Warren Howe: It is interesting when you think about it. The custom target date ... Larger plans, it's gonna be easier for them to do it because they're larger. They have a bigger population base. They have more assets. It's easier to bring in a consultant, do your own custom glide path. Those things cost money, and they have the ability to do it. You see it at the large end of the market. I would say in the smaller to midsize what we're seeing is financial advisors play a very important role in this as well.

Warren Howe: That's where those model portfolios come in. Rather than using an off the shelf target date fund, or for these small plans that don't have the wherewithal to create these custom glide paths, many of them use advisors to select the options for their defined contribution plan. These advisors, as a value add, are creating model portfolios that are asset allocation portfolios that line up with the same thing that a target date fund does. So while you won't have the custom nature of it plan by plan, you'll see a certain advisor create a series of models that they would recommend that the participants of a smaller to midsize plan would utilize.

Sue Lee: Andy, can you elaborate for us the holdings of a typical stable

value portfolio?

Andy Apostol: Sure. Stable value funds have two primary investments. You have the benefit responsive wrap contract, and that is paired with a portfolio of high quality fixed income securities. Each of those two assets are gonna provide some unique characteristics to the stable value fund. For example, the benefit responsive wrap contract is gonna provide a zero percent floor crediting rate. It is also the mechanism that, as bond prices move up and down relative to changes in market interest rate, it's gonna provide that smoothing out effect in terms of the crediting rate that participants earn.

Andy Apostol: Switching to the underlying assets again, as we talked earlier, that's a portfolio of high credit quality fixed income securities. That component of the portfolio provides really the return generator behind the stable value funds. That's gonna provide the principle and interest repayments on the bond. It's generally gonna be high quality to reflect the capital preservation nature of the stable value fund. But those two component pieces actually serve to create the characteristics that are attractive to participants. Stable crediting rate, generally moves in the market, general direction market interest rates, and a return premium relative to money market funds.

Sue Lee: Warren, why are stable value funds only found in defined

contributions, and what role do they play in 401Ks?

Warren Howe: The accounting rules that allow stable value to exist were that it' structured such that it is only available in a defined contribution plan. You cannot get this outside of defined contribution, and that's an important thing. Plan participants that remain in their plan post-retirement, and wanna keep their balances there, they still have access to stable value. If you roll your money out into an IRA, you're no longer gonna have stable value available to you. When you look at those returns, as we've talked about relative to money market funds, for someone who's in retirement and looking to draw down, earning two to three percent versus zero is very important, and then taking the volatility off. If you're in an IRA and you're in a bond fund that can have negative returns over time, that can damage your ability to draw down as you go through a retirement. Staying in a plan to the extent that you can, and having access to stable value is an important benefit for participants.

Sue Lee: Warren, to elaborate, since you can only own stable value funds within defined contribution plans, aside from paying taxes and penalties to withdrawal prior to retirement or other certain criteria, are there any other drawbacks of owning stable value funds?

Warren Howe: I wouldn't consider there to be any drawbacks. As you said, there is certainly a penalty for taking money out prior to 59 and a half, but that is pervasive across all investment options in the defined contribution plan. If you take money out early, you're gonna pay a penalty no matter where it comes from. The same holds for an IRA. If you're in an IRA and you take money early, you're gonna pay a penalty on that money.

Warren Howe: The benefit of being in stable value is, one, the return, two, you cut down on the negative returns that you might experience in a bond fund, three, by being in your retirement plan, you tend to pay institutional pricing. You get better prices on the asset management. You pay less for it. You don't pay for transaction costs that when you make trades within the portfolio, versus when you're in an IRA. All of those you're gonna pay a higher fee in all likelihood, and you're gonna bear the transaction costs for any trades that you make within that. You're not getting as much and paying more in an IRA, and you're getting the benefit of stable value as you remain in defined contribution plan.

Andy Apostol:When we look at the demographics of stable value investors, we would classify them as age-appropriate investors. Years ago, prior to Pension Protection Act launch, stable value was typically a default option within the defined contribution plans. So if you looked at this 10 years ago, 20 years ago, you had people that simply didn't make investment elections that may be in their 20s and in their 30s. The level of participant education that's been initiated by plan sponsors, consultants, has really helped participants migrate into what I'll call age-appropriate investments, so more equity leaning earlier on in their careers.

Andy Apostol: If I looked at my stable value client base, the majority of the assets are in participants that are in the 55, 65 age range that are still maintaining balances. I think a number of those are in draw down mode. Where we do have old line plans, where maybe participants haven't ... The education hasn't worked so effectively. We do see plan sponsors going through a re- enrollment process where they go in, and basically default participants in the age-appropriate target date fund, which moves some of that money that has been historically sticky into stable value fund. So again, that moves the remaining stable value investors into that age-appropriate block where their primary objective is less about growth, and more about income and preservation of accumulated wealth.

Warren Howe: Which is why it's very important for stable value to be a part of those target date structures. It does take off that volatility. It provides for the downside protection. When you think about the target date structures, if you had a custom target date fund, and you knew that on the fixed income side you weren't gonna have any losses, and you were gonna have a very predictable return, maybe when you're setting your model that you take a little bit more risk on the equity side, which is where you're gonna get the bigger return over a longer investment cycle anyways. But you don't have to worry about accounting for a downside on the fixed income fund.

Warren Howe: 30:19 I think we would say that stable value, while it should certainly

be in all target date funds, it doesn't make sense to be in every vintage within the target date funds. If you look at the newer vintages for the millennials out there, they have a long time horizon. They've got 40 years to make up any volatility in the market. It doesn't make sense to necessarily have stable value. But as these vintages roll down the curve, if you will, and get closer to people in the 50s, and 50s going into the 60s and into retirement, that's where we would argue that replacing just pure fixed income with stable value is much more productive for those people.

Sue Lee: Right. We've been talking about stable value and retirement

plans. How is stable value invested differently in 529 plans?

Andy Apostol: Stable value within the context of 529 or college savings plans, a little bit different in terms of the underlying investments. We typically, as well as other stable value managers, use underlying co-mingled fixed income funds to construct those stable value portfolios. Within the context of the 529 plan market, those underlying funds tend to be more separately managed strategies. That's due primarily to the regulations that govern 529 plan investments.

Warren Howe: It is interesting to see the change in 529 plans. 529 dollars have exploded, if you will, over time, as people are taking advantage in college savings, and the dollars are building. You can't really be in a stable value option with zero dollars, and start with one dollar and go from there. You need to have some critical mass to be in stable value, and to have a dedicated portfolio that way anyways. Now that these plans have some history and have been around for a while, many of those plans offered a money market as the capital preservation side. Those dollars have built up.

Warren Howe: People have specific needs at specific dates. I mean it's very predictable, right? At 18, they're gonna start drawing down as kids go to school, so as those money market dollars have built up, it's a great opportunity for the sponsors to look and say compare stable value money market, offer the same at the same liquidity but for a significantly higher return. That opportunity in 529 of replacing money market with stable value is starting to pick up speed at this time.

Sue Lee: I was gonna ask you further on that, because stable value funds are found in a high percentage of 401 plans, K plans, but very few 529 plans. I think out of 51 states, only four maybe do ... Is that a growth opportunity for stable value funds?

Warren Howe: Absolutely. I know Invesco manages several state 529 plans, and the stable value option within those. That's what we're seeing. We're seeing sponsors of these opportunities, or of these plans look and say, "Hey, we've got dollars now. What can we do for the people that invest in this plan that makes it better for their retirement savings?" When you do the comparison, and the due diligence across all of the asset classes, you look at capital preservation. Stable value stacks up extremely well, and outperforms money market. Making that available, and moving money market assets into stable value to give people a higher return, and help the overall college savings is something that we're seeing continue to occur.

Andy Apostol: In the 529 plan space, since stable value has not typically been used as it has been with other defined contribution plans, it seems to be the issue is familiarity with stable value. You're working with plan sponsors in the 529 plan space that may not understand what a stable value fund ... Everybody understands what a money market fund is. I think initially in the construction of 529 plans, it was an easier investment option to put money market funds in there. A little more thought and a little more understanding required for stable value, but we're seeing their consultants are beginning to tackle those issues with the 529 plan market space, and we're getting a lot more interest in stable value over time.

Warren Howe: Then what you see is ... Think about it. A lot of people who are investing in these 529 plans are also in their company's 401K plan. So when you look at what you have available in your 401K plan and you see the investment options, and then you look at your 529 plan and you see what's available, it would've been noticeable that hey, I have stable value at work. I don't have it in my 529 plan. Why not? As it's becoming more prevalent and more available, people put the connection between their retirement plan and their college savings plan. They see something that they like in their 401K plan, and they're starting to utilize it, especially ... Again, it's very predictable. You start putting money in early. Maybe you're a little bit more aggressive. But as you get closer to the need to be paying those tuitions, the dollars tend to migrate to something a little safer so you don't have the downside loss when you need that tuition money. That's where stable value fits in best.

Sue Lee: Steady returns and a risk-tolerant environment sounds pretty good.

Warren Howe: Yes.

Sue Lee: What are the opportunity costs for this piece of mind?

Andy Apostol: I think in terms of opportunity cost, whether it's a 529 plan or a 401K plan, the issue is really your investment trajectory, and how successful you have been, and what your investment horizon is. If you were an early saver, you accumulated the balance that you need to live on in retirement, taking a step to have a more conservative investment approach as you draw nearer to retirement, or in the case of 529 plans, your investment horizon is much shorter. Your kids are going to college on a certain date, so the actual investment experience that you recognized up to that date, a more conservative investment option ... If you've saved enough to meet those college objectives, I don't see the downside. If you haven't, if you were a late saver in the 529 plans, and you may be continuing that process as your kids are going through college, you may benefit from having a little more risk in the portfolio, a little more upside potential not being invested in the stable value fund in an effort to fully fund the college education requirements.

Sue Lee: Andy, can you also speak on how stable value fund fees have changed over the last few years?

Andy Apostol: Sure.

Sue Lee: Several years.

Andy Apostol: Yeah, sure. Just a brief history on stable value fees. They started when stable value funds moved to wrap contracts in the late '80s and early '90s. They started at a range of 30 to 40 basis points. They rapidly declined, really pre-financial crisis. Fees for wrap contracts dropped seven to eight basis points going into 2007, 2008. Unfortunately, so did the size of the number of wrap issuers willing to participate in this business. At seven to eight basis points, we had eight to 10 wrap issuers that were actively engaged in the stable value market. That seemed okay at the time.

Andy Apostol: Looking at this post-financial crisis, the universe wasn't large enough, and it wasn't healthy enough to have only eight to 10 wrap issuers in there. Post-financial crisis unrelated to the business metrics of stable value funds, there were insurance companies and banks that were issuing this contract. They basically stopped issuing. They did a study of their lines of business, stopped issuing all sorts of new investment contracts. Stable value, it was lumped into that. For the first time, we had a limited supply of wrap contracts post-financial crisis, which put some upward pressure on fees.

Andy Apostol: I'd say that was needed upward pressure on fees in the sense that it stimulated a much broader interest in participating in the wrap market. Fees jumped from eight, to 10, to 15 into the low 20 basis point range over the last decade, but so did the number of companies issuing wrap contracts. That went from eight to 10. We're at 18 to 20 issuers that are in the market today that are actively seeking stable value business.

Andy Apostol: Another positive impact of the constrained wrap capacity, as Warren touched on, was wrap contract guidelines that were virtually nonexistent pre-financial crisis. The language in the wrap contracts that covered investments was so broad, basically saying you can buy high quality fixed income securities. The pendulum definitely swung in the other decision post-financial crisis in terms of having much more detailed guidelines, which I think was a positive factor for the industry, because what I call ... It curtailed the outlying ... The outlier strategies. There were some managers that were pushing the envelope in terms of the under ... The securities. There was some stable value funds that had equities in there. Some inappropriate investments for the capital preservation option.

Andy Apostol: I think there was a significant benefit in terms of maybe unifying

what a stable value fund ... I shouldn't say unifying. Having a more consistent investment approach across managers across stable value for stable value fund holdings. What we've seen for fees that hit a peak in say 2016 in the high 20s, we're seeing wrap fees in the high teens today. That hasn't had an impact on the number of wrap issuers that are actively pursuing business in the market. I think fees in the mid to high teens over the next five to 10 years is something that would be reasonable and sustainable for stable value investments.

Sue Lee: And investors would be more than happy to pay for.

Andy Apostol: You're always mindful of fees, but when you look at the fees relative to the characteristics that you're getting in the stable value fund and the returns that you're getting in the stable value fund, stable value funds even on a net fee basis has such a compelling risk return characteristic and return premium over money market funds. I think that's just the price for the packaging of the stable value offering.

Warren Howe: Absolutely. As Andy said, so when stable value began, pricing for wrap contracts were in that high 20s approaching 30 basis points. As it came down, I think it's akin to what goes on with participant behavior. As new entrants came in, people didn't understand that there was actually risk by putting these guarantees around these portfolios. So as a wrap provider, you have to have ... You have to hold capital against these guarantees. You have to earn a return on the capital. There are portfolios where you're the one on the hook for the returns on these portfolios, or at least the guarantee to pay book value if something should occur.

Warren Howe: I think a lot of wrap providers got in looking at nothing that had

ever occurred, and thinking that it was more of a commodity, which drove pricing down. Then just like participants, as soon as risk was realized, that there actually is true risk, with participants, they leave the equity markets and come to stable value. With some of the wrap providers who were newer to the business and didn't understand the true nature of the risk that's there, they exited the market after driving fees down.

Warren Howe:  Now you have what I will call a more return to normalcy. It's not

at the levels that it used to be. It's not at the low levels that it was, but I would say it's moderated in a very good place for the total package of what's the risk, what's the returns, what's the risk-adjusted return, and what are you getting for that total package. There's always pressure on fees. Wrap fees are one component. Asset management fees are another component. Recordkeeping fees are another. I think you've seen a general trend over the last five to seven years of all of those fees getting a little bit tighter.

Andy Apostol: If we look at the financial crisis, I think a lot of good things came out of that. It really demonstrated stable value came out of that virtually unscathed in terms of the stable value funds meeting their objectives, even in unprecedented spread widening that impacted the stable value fund financial positioning. Met the investment objectives. It strengthened the industry in terms of number of issuers, the types of wrap contract provisions, the relationships between stable value managers and wrap issuers just in terms of those contract negotiations, more detailed guidelines so that the wrap issuers are comfortable with them, the stable value managers are comfortable with them. We're able to construct a product that is more uniform for the industry with the constituents that are involved in this, whether it's a stable value manager, a wrap issuer, a consultant, a plan sponsors, having just much more confidence in that stable value is gonna continue to perform well in the future.

Warren Howe: It really highlighted the need to understand who you're working with, and who your partners are. It highlighted the need for experience, whether it be the stable value manager who has been through market cycles and understands how to manage these portfolios, and understands that these are capital preservation portfolio, and you shouldn't have investment guidelines that are shooting for the stars. At one point, there was pressure on people. Why aren't you investing in this or investing in that to give a better return?

Warren Howe: People that held to their knitting and stayed with no, this is capital preservation. This is what it's supposed to be. That experience, and people who understand how to manage those portfolios is important for plan sponsors, just like the wrap providers who understand the risk, who understand the market to book variance that's going to occur, that are committed to being there and in the industry. I think plan sponsors have been able to look and understand how important it is that the manager you pick, the wrap providers you pick are people that understand this business, and aren't just looking to get in and possibly get out when you need them.

Sue Lee: So previously, a criticism for stable value funds was a lack of transparency. Is this still an issue?

Andy Apostol: I'd say post-financial crisis, the level of transparency is certainly more apparent to both plan sponsors, consultants and participants. Pre-financial crisis was an interesting time. It was almost a don't ask, don't tell time in the sense that stable value was really almost viewed as a money market fund. It was a money market fund substitute, just a little bit better. I don't think people really ... The industry was really aware what a stable value fund was. During the financial crisis, we would get calls from plan participants just in an absolute panic having lost significant amounts on their equity portfolio, and then not understanding what a stable value fund is.

Andy Apostol: That's really, as Warren and I got involved in participant level communications, that was eyeopening to me, because the language that I was using in participant communications was extremely clear to me. Capital preservation. I had all of the buzzwords in there. It didn't mean anything to the panicked investor. We retooled our communications program to really make sure that we're describing this in a way that resonates with individual plan participants.

Warren Howe:That transparency is prevalent across the defined contribution universe. Now if you look at it, recordkeeping fees are much more clearly defined. If there's an offset for recordkeeping fees because you use a certain investment option to keep it, that's transparent. There's no more ... I won't say hiding fees, but there's no more the opaqueness of fees that are out there in the market. I think that's true for a recordkeeping fees, for stable value fees, for management fees, for rapid ... It's much more transparent across the defined contribution universe at this point. That's a good thing.

Sue Lee: Warren, can you also discuss for us stable value's role in decumulation?

Warren Howe: Sure. If you think about participant behavior and the whole inception of the defined contribution plan, it has been from that inception point about accumulating, accumulating, accumulating. The redesigns that have occurred have been about investment options, and how best can participants accumulate dollars. There's been this huge focus on accumulating wealth, but very little to this point has been about okay, once we help them get to the point of retirement and they've built this pot of money, what do they do with it? How do they spend it down? How do you make sure somebody doesn't go out and just buy that boat, and all of a sudden a few years later they have no money?

Warren Howe: There's a bigger focus across the defined contribution industry right now about helping people take dollars they've accumulated, and decumulate them over time. Now the only way to not outlive your balance is through an annuity, and if you have an annuity option, and I think most people would say it's an opportunity to have a guaranteed income stream. It's certainly not something that people would say you need to put your entire balance in, but maybe you put an annuity to cover some costs and invest the remainder.

Warren Howe: But where stable value plays an important role is you've got that fixed, stable, predictable return that's not gonna have the downside volatility of bond funds. People know what they're going to be earning, and they can use that as a predictor of what the yields are gonna be, and then draw down with systematic payments over time, and use stable value as that anchor or that guarantee that they know what they're gonna get as they take those withdrawals going forward.

Andy Apostol: It's difficult to determine what the DC plan will look like in the future. Target date funds have been around and largely popular for the last 10 years. The uncertainties are what market environments are we going to go through, and what the participant behavior has been. You think back to the end of 2018. Very volatile market, environment for the equity markets. Participants didn't really move. We saw a little cash flow going into the stable value fund. If that were 15 or 20 years ago, we would've seen large dollars moving into stable value in response to negative equity returns. I think that speaks to the effectiveness of the participant and plan sponsor communications, and the education, and the sophistication of defined contribution plan investors.

Andy Apostol: But what happens in the future in terms of will participants stay in a target date fund that's not gonna be 100% capital preservation? Will they look at their balances and say, "I'm all for capital preservation if I can earn a competitive rate on the capital preservation fund. That's all I'm looking to do." There's just uncertainty in terms of what trajectory will shape participant behavior longterm in the next 10 to 20 years. Will they stay invested in the 401K plan? Are they gonna be pulling their money out at 65 when they retire? Will they gradually start pulling that money out at 72 and a half, and later age brackets?

Sue Lee: Because you guys both have your ears to the ground, I have to

ask. With the workforce in this country changing, with millennials not necessarily staying in a company for 20, 40, whatever years that American workers have, how are stable value funds going to change, especially if you can only be invested in defined contribution plan?

Warren Howe: Well, there's a couple different ways, right? There is certainly a changing workforce. What you would see if you're working in the normal economy, if I can call it that, what you would see is many of these companies are gonna have their 401K. Many will have stable value as an investment option within that. But to the point about target dates and the growth of target dates, many of the millennials are just investing in the target date because that's what they're conditioned to do, and that's gonna take care of that. There's certainly an erosion in stable value assets as it relates to target date funds, which is one of the things we were talking about as to why stable value should be in target date fund for the asset class, but also not just for the asset class, but for the benefit of the participants that are in that structure.

Warren Howe:But if you have more of this gig economy where people are not necessarily part of the corporate environment and having access to plans, you're starting to see some of these states offer state- sponsored defined contribution plans for workers who are not covered under a normal corporate 401K plan. As those plans get up and get running and build assets, I think what you're gonna see is similar to 529. Money market assets that start to accumulate are going to be built up. Sponsoring entities are gonna look at what are the best investment options available. We need capital preservation. Stable value stacks up really well. I think, from that perspective, there's an opportunity with the state- sponsored plans.

Andy Apostol: Participants really only lose out on the opportunity to have stable

value if they're moving from a company that uses a stable value fund in their DC plan to a company that doesn't use stable value. As long as the old employer and the new employer have stable value as an investment option, it's really a portable investment. You move from one company's stable value fund to the other company's stable value fund. As Warren pointed out earlier, they really only lose out on the stable value opportunity if they move to an IRA account that stable value is not typically part of.

Sue Lee: Or the gig economy, which Warren-

Warren Howe: Right, where they're not employed in the normal corporate structure, and they're freelancing. They're on their own, and they're looking for ways. These state-sponsored plans we think will start to create some access, as long as stable value is included. When we talk about stable value too, I think it's important to understand there's different ways to access stable value. The larger corporations ... Invesco is one of them where they will manage a dedicated portfolio if you're a very large company. It's just a portfolio for you. But there are a lot of small plans out there that wouldn't have access to stable value, because they don't have the asset size.

Warren Howe: That's where these pooled or collective fund stable value opportunities come in. That's just taking a lot of small plans, and everybody's putting their money together into a pooled fund so that plans that otherwise wouldn't have access to stable value now have access to the benefits of stable value. I think that's an important thing, because it's almost half the plans that have stable value available are invested through these pooled funds. That's a way to get to the market.

Andy Apostol: It's certainly more portability with the pooled fund market, because as plan sponsors change record keepers, the pooled funds are in multiple platforms. So in that instance, you basically can maintain your stable value investment across recordkeeping platforms.

Sue Lee: Just final thoughts around the table. Why are you so passionate about stable value funds?

Andy Apostol: I'm reaching an age where I actually have some money invested in stable value. It's been a lifetime. I was an early saver. Lifetime of saving within my 401K plan, and I see that it provides a fantastic capital preservation anchor. I'm not 100% invested in stable value, so I have a blended strategy in place. I like the characteristics of what stable value offers in terms of the return positioning, the stability. I can create my own blended portfolios within the defined contribution plan, and using stable value, it provides some really compelling risk return characteristics.

Sue Lee: Warren?

Warren Howe: I think it's just a great value for participants. I think about it in terms of the safety that it provides. Whenever we've seen huge swings in market volatility, whether it be the financial crisis in 2008, whether it be the large market swings in equity markets in December of 2018, October of 2018, when people need a safe place to go, they go to stable value. Stable value is there to give them that safety, and give them that positive return that they're looking for. It plays a very important role in the safety net for millions of defined contribution participants.

Sue Lee: All right. Thank you both for sharing your thoughts with us

today.

Andy Apostol: All righty, thank you.

Warren Howe: Thank you.

Sue Lee: And thank you for watching. Our experts today were Andy

Apostol, the head of stable value client service at Invesco, and Warren Howe, the national director for stable value markets at MetLife. From our studios in New York, I'm Susanna Lee. Thank you again for watching Asset TV's stable value masterclass.