Although the Federal Reserve's normalization of interest rates will likely give a boost to money market yields, retirement consultants recommend stable value funds as the best capital preservation option in defined contribution (DC) accounts.
More than eight in 10 consultants said they are likely or very likely to recommend stable value to plan sponsors seeking alternatives to prime money market funds (MMFs), according to PIMCO's 11th annual 2017 DC Consulting Support and Trends Survey. By contrast, only 21% said they would recommend that plans keep their prime money market option.
These results give further impetus to stable value, which has been a fixture of DC plans since their debut in the early 1980s. Unlike other common capital preservation options, such as money market funds, stable value has the potential to help preserve the purchasing power of participants' invested capital for use in retirement.
Indeed, low yields have tarnished the appeal of MMFs. And with the market pricing in fewer interest rate hikes in coming quarters, we think it unlikely that MMFs will outperform inflation anytime soon. Moreover, the SEC's sweeping money market reforms last October added potential gates and fees to prime MMFs, further eroding their attractiveness and causing many sponsors to move into lower-yielding government MMFs.
In PIMCO’s DC Consultant Survey, which captured opinions from 69 U.S. consulting firms serving over 12,000 clients with DC assets in excess of $4 trillion, 64% recommended stable value over government MMFs, which were not affected by the SEC's regulatory reforms.
Asset flows suggest plan sponsors and participants agree with consultants' recommendations: According to the Stable Value Investment Association (SVIA), stable value assets rose by nearly $30 billion to $819 billion in the year ended 31 March 2017. Industry-wide weighted-average crediting rates are about 2.5%, according to the SVIA. This includes the performance of individually managed stable value accounts, pooled stable value funds and insurance-company-guaranteed insurance accounts – a stable value investment option entirely offered and guaranteed by a single insurance company.
PIMCO views capital preservation options as essential elements of a DC plan’s core investment lineup. They offer the potential to preserve principal, generate income, and should provide a liquid, low-risk investment during volatile markets or offset riskier investments in a portfolio.
Liquidity, low-risk and long-term real returns
When it comes to selecting a capital preservation option, PIMCO has long suggested sponsors focus on a few important investment characteristics:
- Liquidity. In the capital preservation context, we believe liquid investments must be easily converted to cash not only in normal markets, but also when markets are stressed.
- Low risk. We believe the value of a low-risk capital preservation investment should be reasonably assured over an appropriate time horizon as determined by the sponsor – whether daily, monthly or quarterly.
- Real returns. Generating an after-inflation return on investment capital is also an important, but often overlooked, consideration given the long-term retirement savings objectives for DC participants.
- Active Management. In today's low interest rate environment, we think an active approach is critical. For example, the median active intermediate-term bond manager has outperformed its passive peer by about 50 basis points over the last 10 years – unlike its equity counterpart.1
These gains may compound over time and can represent meaningful total return potential. For more on active management, please see "Why Bonds Are Different."
Since the capital preservation needs of each plan are unique, it's possible that a MMF remains appropriate for a particular DC plan. But clearly DC consultants, sponsors and participants have recognized the changing value proposition of MMFs.
Alternatives for DC
For sponsors considering moving away from MMFs or simply seeking to review their current option, PIMCO has extensive expertise on alternatives that sponsors have used to fulfill the role of a DC plan’s most conservative option. These include short-term bond funds specifically designed for use in DC, stable value and white-label (or custom) solutions.
1 Based on Morningstar U.S. Intermediate-Term Bond Category for fixed income and Morningstar U.S. Large Cap Blend Category for equities. Institutional share class. As of 31 December 2016. Source: Morningstar.