Negative Alpha Factors in Stable Value - from Core Plus to Competing Funds

Abstract

Stable Value is the dominant fixed income option in the rapidly growing Defined Contribution market. Many plan sponsors and their consultants continue to inadvertently make decisions that create negative Alpha for their plans. The most common of these is trying to force Core Plus and other total return styles with wide latitude in investment guidelines into Stable Value options. Running the underlying bond investments in a Stable Value fund, similar to total return fixed income in a DB plan, can have significant negative Alpha effects. Even using a Lehman Aggregate Index as a benchmark could lower alpha because of its potentially high and somewhat volatile duration. This matters because fixed income managers need a synthetic GIC wrap provided by an Insurance company or derivatives desk of a money center bank to make stable value work. Wrappers force terms that can lower the alpha. With understanding of how these terms work, fixed income managers with proper structures and planning can create higher Alpha portfolios.

A second misstep entails changes made in plan administration, for legal and other reasons, that create unintended consequences on the risk of the Stable Value option. Stable value is based on a shared experience between participants. Plan structure changes that affect the potential cash flows and allocations force wrappers to impose restrictions that can lower the Alpha as well. This article isolates some of the unique performance factors of Stable Value to help consultants, managers and the plans maximize Alpha.

Keywords: Stable Value, Fixed Income, Core Plus

JEL Classification: G11, G18