Friday, May 21, 2010
Another Impossible Product
"Some big changes are happening in funds favored by safety-seeking retirement savers. ... 'What the credit crisis exposed is that these vehicles are much more complex than people assumed,' says Steve Deutsch, who tracks the funds at investment-research firm Morningstar Inc. ... This added protection allows investors to trade in and out at a relatively stable value rather than at the underlying portfolio's actual market value, which can bounce around. ... Some funds' market value dropped sharply, making them more reliant on their wrap contracts to deliver book value to investors. That, combined with general bond-market upheaval, made issuers more reluctant to offer the protection. Though the market has stabilized, there is still a significant shortage of wrap contracts, causing higher fees and other headaches for stable-value funds [SVFs] and their investors. ... The Employees Retirement System of Texas, which administers 401(k) and 457 plans for state employees, late last year decided not to renew its contract with its stable-value provider. Its fund's market value early last year dropped to just 89% of book value--helping to push the 'crediting rate,' essentially the yield investors receive, to 3% currently, down from 4% at the start of 2009. ... The shortage of wrap contracts is causing come managers to hold bigger cash stakes, a drag on performance. ... Given the great demand and limited supply of wrap contracts, the issuers of these contracts have plenty of power to dictate their own terms, which aren't always favorable to investors. One outcome: higher fees. ... The wrap provides 'can be as strict as their want to be on terms,' says Chris Tobe, a senior consultant at Bridenbach Capital Consulting who helps employers review [SVFs]. ... All this adds up to lower returns for investors. The average [SVF] delivered 3.1% last year, down from 4.6% in 2008, according to Hueler Cos., which tracks the stable-value industry. ... Investors may also find tighter restrictions on their ability to move from the funds to other investments. Many [SVFs] have long considered certain other investment options, such as money-market funds 'competing funds.' ... Stable-value investors also are vulnerable to rising interest rates. When rates start to rise, yields of money-market mutual funds will likely tick up faster than those on [SVFs]. ... Many newer stable-value products have a number of different wrap-contact issuers, ensuring that investors can trade in and out at book value. Amid the shortage of wrap insurance, though, some firms are seizing the opportunity to reintroduce older types of stable-value products that are backed by a single insurer and carry considerable risks", my emphasis, Eleanor Laise at the WSJ, 1 May 2010, link:
SVFs always struck me as a scam. They are sold as if they are bank deposits. If you want to be able to redeem your "investment" at par, you should hold bank deposits. But they pay lower interest rates than other "investments". Precisely. The limit to how "strict" the wrap providers can be is the bank interest rate. The existence of SVFs is another result of Zimbabwe Ben's zero interest rate policy. Of course SVF interest rates change slower than money-market funds. SVFs have longer maturities than money-market funds. Mencius Moldbug has done some fine work describing maturity transformation, which is what SVFs try to sell.