Government Money Market or Stable Value Funds? Which One Should You Offer?
In October of last year we wrote a blog post outlining changes that plan sponsors must do in order to comply with the SEC money market reform. As a quick reminder, the rule established redemption gates and fees, as well as a floating NAV for institutional prime money market and municipal funds.
The implementation of the rule forced plan sponsors to reconsider their “risk-free” options and make adjustments to their investment menu. According to Callan Associates, 64% of plan sponsors either replaced their existing money market funds, or completely eliminated them from their investment menu since the commencement of the rule. Out of these plan sponsors, 13% replaced money market funds with stable value funds while 61% switched to government money market funds.
Money market funds have always been dominating investment menus as a capital preservation option. They are liquid, transparent, and easy to understand. This is exactly what plan participants want and need. However, a relatively new trend has emerged recently. A good amount of plan sponsors started offering stable value funds in their investment menus. While stable value funds have been around since the 1970s, they have been sitting on the sidelines waiting for their time. With the SEC money market reform, it looks like that time may have come. Let’s explore the differences between government money market funds and stable value funds.
Government Money Market Funds
After the SEC money market reform came into the effect, institutional prime money market funds that served as a cash alternative for plan participants have lost their appeal. Due to floating net asset value, you can no longer consider them “risk-free” since they can now trade below $1 and carry the risk of principal loss. In addition, with the imposition of redemption fees and suspension periods, there was absolutely no sense in offering institutional prime money market funds to plan participants.
Luckily the reform left plan sponsors some room to maneuver. Government money market funds are required to maintain a net asset value of $1 and usually, even though they are allowed to, don’t impose redemption fees or suspension periods. Yes, they yield less than institutional prime money market funds. But they are risk free and certainly a better option for plan participants who need to temporarily allocate their funds to cash equivalents during market turmoil.
Stable Value Funds
Being used to common and conventional things, many plan sponsors were reluctant to look for other capital preservation alternatives. However, the SEC reform has once again served as a catalyst for potential change. The use of stable value funds has recently been gaining some popularity in defined contribution plans.
The only common thing between stable value funds and government money market funds is that they both maintain a net asset value of $1. Stable value funds can exist in several forms including insurance contracts, bank collective trusts, and separately managed accounts. Perhaps the biggest difference between money market funds and stable value funds is that the latter are not subject to SEC regulations. Because of this, they don’t have the same level of disclosure and reporting requirements as money markets funds do.
Another difference between money market and stable value funds is the asset allocation. Stable value funds invest in high-quality, short-to-intermediate term fixed income investments that are protected from changes in interest rates by contracts from banks and insurance companies. In addition, stable value funds can invest in traditional insurance investment contracts (periodic payment in return for lump-sum investment). Thus stable value funds provide a higher rate of return.
Being exposed to short and intermediate term securities that can widely fluctuate in price inevitably causes pressure on funds' net asset value. In order to protect a NAV from dropping below $1, stable value funds have to purchase insurance against market fluctuations that allows them to use book value instead of market value accounting.
Stable value funds, like any other investment vehicles, possess risk and may impose multiple restrictions which fiduciaries should be aware of. For example:
Bankruptcies among insurance companies are rare, but can still happen. It is important to know the financial health of an insurer of a stable value fund.
Exiting a stable value fund and replacing it with a different stable value fund or other cash equivalent alternative is difficult since the stable value fund manager needs at least 12 months of notice. This restriction may significantly limit plan sponsors’ ability to adjust their investment menu.
Plan participants may be restricted from exchanging a stable value fund into other investments for a certain period of time (usually up to 90 days).
Participants withdrawals caused by corporate actions (layoffs, mergers, division sales, etc) may be paid out at a less than book value.
Which Fund is Better for Your Plan?
At first sight, stable value funds look like a no go due to their complexity and restrictions. However, stable value funds have a much higher rate of return at basically the same (if not less) level of risk. For you as a plan sponsor, this is an extremely important point that can be a good service for your plan participants. For example, if your plan consists of older employees who need to preserve their capital, a stable value fund can be a much better option than a government money market fund.
Furthermore, stable value funds can serve as a true diversifier in plan participants’ portfolios as these funds have diversified portfolios of fixed-income securities that are protected from any fluctuation in interest rates.
On the other side, government money market funds are more transparent, easy to understand, and liquid. If you see that your plan participants tend to temporarily park their money in cash vehicles in order to protect principal from any short-term risk, then government money market funds may be a more appropriate option.
In order to answer the above question, fiduciaries need to undertake a prudent process and thoroughly evaluate each investment vehicle before making a decision. They need to take into account plan design as well as participant demographics and behavior.