Introducing Stable Value in Target Date Allocations

As target date funds have become more prevalent, however, many advisors are beginning to wonder if there might be room for improvement.

Target date funds were first introduced in the early 1990s and have grown in popularity ever since. At the end of 2018, according to the Employee Benefits Research Institute (EBRI), target date fund assets accounted for approximately 27% of total 401(k) assets in their database. The call is understandable. Many 401(k) plan participants are not very knowledgeable about investment selection, so a profitable, professionally managed allocation offers an alternative.

According to a 2022 Stable Value Study by Metlife, 89% of plan sponsors and 97% of plan advisors said they would be interested if a target fund provider could offer a solution “that delivers net returns four times the cost associated with providing these additional returns (e.g. improved net returns of 60 basis points at a cost of 15 basis points) while maintaining constant volatility.

Stable value funds may have the potential to offer this type of trade-off under the right circumstances; however, this asset class is not typically found in ready-to-use target date funds due to the constraints of the Employee Retirement Income Security Act (ERISA). This is why many advisors might consider solutions such as predefined allocation models using a stable value fund already available in the plan’s general range or, alternatively, a set of target date collective investment funds (CITs). personalized with a stable value as a key asset.

The academic literature supports this development. In “Stable Value Funds Performance”, Babbel and Herce performed efficient frontier analysis, which is central to modern portfolio theory, and demonstrated that stable value should be an important component of any efficient frontier where it it is an available asset class. Specifically, the authors concluded that stable value tends to dominate both bonds and cash, which are the common diversification assets currently used by traditional target date funds.

The efficient frontier is defined as the set of optimal portfolios that offers the highest expected return for each assumed level of standard deviation. Portfolios that are constructed to lie on the efficient frontier curve are said to be optimal, while portfolios that lie below the efficient frontier are said to be inefficient or suboptimal. To construct an efficient frontier, an advisor needs three pieces of data for each potential asset class: the expected return, the expected standard deviation, and the expected correlation of the asset classes to each other. Overall, the best constituents of individual asset classes tend to be those that show high returns relative to their standard deviation, while being less correlated to other asset classes.

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In 2018, Babbel and Herce also concluded that the stable-value asset class was “dominant” because it offered enviable returns with a low standard deviation. To see if these conclusions still hold true today, we have analyzed below the yields and standard deviation of bonds, money market and stable value over the past 15 years:

Annualized return (1/1/2007 to 31/12/2021)

Standard deviation (1/1/2007 to 12/31/2021)

Main obligations

3.98%

3.60%

Money Market

0.72%

0.38%

Steady value

2.56%

0.28%

Source: Morningstar Direct Category Performance, 2022. Core Bonds = US Fund Intermediate Core Bond, Money Market = US Fund Money Market – Taxable, Stable Value = Morningstar US CIT Stable Value GR

At first glance, the results above may seem too good to be true. How are stable value providers able to consistently outperform money market funds with a comparable standard deviation? The secret lies in the ability of issuers to subscribe to the behavior of participants. For example, while an individual participant can buy and sell their investment at any time, issuers know that collectively an overall plan will generally have relatively stable cash flows into the overall investment. As a result, the stable-value issuer can then invest in longer-term, higher-yielding assets, which benefits all participants, regardless of how long they individually invest in the fund.

The Investment Company Institute estimates that stable-value funds currently account for about $900 billion of the $7 trillion in DC plan assets. Yet stable value as an investment does not seem to be fully appreciated by the typical investor. This is likely because the use of the asset class is limited to tax-eligible vehicles such as defined contribution plans. Wall Street’s inability to sell stable value directly to retail investors is a likely factor in the limited domestic marketing exposure of this asset class.

The stable value fund industry has been around since the 1970s and has consistently outperformed money market funds since then. However, this comes with some constraints. First, a plan is usually needed to avoid other competing investments such as money market and short-term bond funds. Second, a plan must make a long-term commitment to the asset class, as removing the asset entirely from the plan lineup may require notice or potentially trigger a market value adjustment. Both of these constraints are necessary to provide the issuer with the cash flow stability needed to invest in longer duration assets.

It should be noted that there is an additional potential risk for the issuer which is not fully taken into account by the modeling of the efficient frontier. However, on the positive side, the stable-value fund industry has already been stress-tested by many significant world events – the inflation of the 1970s, the technology of the 1990s, the boom and subsequent crash. , the Great Financial Crisis and the recent pandemic, all without major incident so far. However, it should be noted that past performance is not an indicator of future results.

Stable value already occupies a significant share of the pension industry’s overall assets, accounting for around 10% of the total defined contribution market,[1] despite limited commercialization to the public and nascent use in predefined allocations and custom target date collective investment trusts. As more advisors and plan sponsors become aware of these alternatives to traditional target date funds, stable value funds are strongly positioned for consideration in diversified portfolios.

Kent Bartell is director of investment research at The Standard. He has over 25 years of experience in portfolio management and financial services. Kent holds the Chartered Financial Analyst® and Fellowship designations of the Society of Actuaries. He graduated from the University of Michigan with a bachelor’s degree in mathematics and a master’s degree in business administration.


[1] Stable Value Investment Association (SVIA) Quarterly Stable Value Characteristics Survey SQ2021.

James V. Hayes