Is The Best “Cash” Alternative Available Through Your 401(k) Plan? What You Should Be Aware Of About Capital Preservation.

Money market funds, stable value funds, and fixed accounts all have distinctive qualities that should be assessed on a regular basis even though their objectives are identical.

 

Any discussion of capital preservation in a defined contribution plan may leave plan fiduciaries perplexed or uninterested. But just like the offensive line during a game-winning drive, its significance becomes most clear when things are chaotic. When talking to recordkeepers and investment managers, fixed account products and stable value funds have risen to the top as one of the few asset classes still offering participants a positive nominal rate of return.

Although they may fall under the “cash” category on the investment menu for defined contribution plans, some investments may be better classified as cash-like. Many have unusual terms and conditions that could be difficult to understand later. Here, we’ll try to outline the numerous types of investment products that can be utilized as the capital preservation option on a plan menu, explain how they differ from one another, and outline the factors that need to be taken into account.

 

Three main kinds of capital preservation

Money market fund. The easiest way to explain it is as a fixed income mutual fund that invests in good credit grade, short duration securities. No of the state of the economy, money market funds are structured to maintain a net asset value (NAV) of $1.00. Because returns are closely correlated with interest rates, it can be difficult to provide a steady yield.

Stable value funds, which typically maintain a diverse portfolio of fixed income securities with short and intermediate maturities. Stable value funds have an explicit expense ratio and offer participants a guaranteed rate of interest based on the underlying securities.

Fixed accounts are similar to stable value funds in that they feature an interest rate that is guaranteed. However, on occasion, rather than being determined by the market, those rates are negotiated, and an explicit expense ratio might not exist.

 

Three factors must be considered when evaluating your current capital preservation offering: transparency, mobility, and termination clauses.

Transparency

All money market funds are expected to maintain a certain level of openness by law and are regulated under the Investment Act of 1940. They are the only investment in capital preservation covered in this article with a ticker symbol, making them easy for investors to examine.

Stable value funds often do not have a ticker symbol because retirement plan members can access them through collective investment trusts. This makes research on the underlying securities of stable value funds more difficult, but not impossible. Statements produced by stable value providers include fixed income classes like treasuries, asset-backed securities, and municipal bonds that they include in their core bond holdings. Additionally, stable value funds typically have a clear expense ratio that can be utilized as a benchmark.

It is challenging for participants to do research independently of what is offered directly to them because fixed accounts are available through a variety of vehicles, most notably separate accounts or commingled money. Fixed accounts may also include asset classes that aren’t often included in capital preservation products, like subinvestment grade credit and even alternative investments. Last but not least, a lot of fixed accounts are spread products; the amount that the account provider is collecting (the spread) is the difference between the portfolio’s earnings and the promised crediting rate. Because they may fluctuate as frequently as quarterly, it can be exceedingly difficult for a fiduciary to accurately benchmark expenses.

 

Portability

The capacity to transfer these assets to another fund or provider is the next factor to be taken into account. We focus more on the plan level than the participant level when evaluating portability. Participants nearly always have quick access to the money market, stable value, or fixed account funds’ assets.

Money market funds are registered mutual funds under the Investment Company Act of 1940, as was previously mentioned. A recordkeeper with an open architecture platform should therefore permit a range of money market funds. On the other hand, not every recordkeeping platform offers stable value funds. The availability of the desired stable value fund should be confirmed by plan fiduciaries who are conducting a stable value search or thinking about switching recordkeeping providers. Due to their proprietary nature, general accounts are virtually entirely non-portable. The opportunity to switch the product to another provider is only sometimes available because the fund normally participates in the recordkeeper’s general account. Should the plan decide to switch recordkeepers, this could become a financial hardship for the participants.

 

Termination provisions

Similar to portability, termination clauses will have a considerably bigger effect on the plan as a whole than on individual participants. Most capital preservation solutions do not include termination clauses in their contracts at the participant level, but they frequently do at the plan level.

Should a plan desire to switch from money market funds to another capital preservation product, they may do so just as they would with any other mutual fund on their investment menu. A government money market fund cannot gate (or limit) withdrawals in the event of a recordkeeper transition.

A 12-month put is the most typical plan level termination clause used in stable value funds. In essence, a 12-month put mandates that plan sponsors give the fund one year’s notice before terminating it. The put is intended to shield the remaining fund investors from a drop in market value.

Fixed accounts occasionally feature a market value adjustment in addition to a 12-month put, though (MVA). In the event of plan level termination, an MVA is a monetary adjustment that may be made to the fixed account contract. Participants would only get a fraction of their remaining amount, based on the market-to-book value at the time of termination, if it were to be applied. Market-to-book ratios can be far lower than 100% in an environment with rising interest rates, like the one we are currently in.

Due to all of these factors, it is crucial that retirement plan fiduciaries regularly assess the benefits of their capital preservation fund. Capital preservation funds may occasionally offer the only positive nominal returns available in an investment menu, as we have witnessed in 2022. Money market funds, stable value funds, and fixed accounts all have distinctive qualities that should be considered even though their objectives are similar. Participants might be at a loss if the plan switches recordkeepers because of the product’s transparency, portability at both the plan and participant levels, and the applicable termination conditions.

 

 

 

 

Source: https://www.benefitspro.com/2023/01/02/does-your-401k-plan-offer-the-best-cash-option-what-employers-need-to-know-about-capital-preservation/