Monthly Archives: January 2015

STABLE VALUE CHARADE: Analysis Shows “Multi-Manager/Multi-Wrap” Scheme a Bad Deal For Participants But A Money Maker for Your Consultant

More and more plan sponsors have moved to create Custom Stable Value Funds for their plans over the past decade, and this has been a tremendous benefit for plan participants. Custom Stable Value Funds offer greater fee transparency, lower fees (in most cases) and avoid the risks inherent in “pooled” arrangements with other plan sponsors over whom you have no control. They also permit the plan sponsor to exercise more control over investment policy and portfolio quality.

Evolution of “Multi-Manager/Multi-Wrap” Stable Value Funds

When most plan sponsors first created their Custom Stable Value Funds, they were usually composed of one investment manager and one “wrap” provider. The “wrap” provider (generally an insurance company) guarantees liquidity for book value benefit payments to plan participants. In some situations the investment manager was also the wrap provider and in other situations the wrap provider was different.

As the assets in Custom Stable Value Funds have grown, there has been a trend to move away from “single -manager/single- wrap provider” arrangements to “multi-manager/multi-wrap provider arrangements.” Some consultants recommend the “multi-manager/multi-wrap” design because they argue that diversification of managers and diversification of wrap providers is better than the “single –manager/single-wrap provider” design. However, a recent analysis of several large Governmental Custom Stable Value Funds calls into question whether the “multi” arrangements have any real benefits for plan participants. To the contrary, the analysis shows that most of these “multi” funds have significantly higher fees and lower yields than their “single” counterparts.

“Multi-Manager/Multi-Wrap” Generally Means “Multi-Layering of Fee Upon Fee”

For our analysis, we examined publicly available information on over two dozen large State, County, and City defined contribution programs. While the sampling was random, it included a diverse number of plans with different vendors, managers, consultants and plan designs.

Without exception, every single “multi-manager/multi-wrap” Custom Stable Value Fund had higher overall fees, and lower overall yields than funds of similar size that used the “single-manager/single-wrap” design.[1]

  •  In some situations the differences were startling:

Two adjoining states have Custom Stable Value Funds. For the one state (let’s call it State ‘A’), the assets in the Custom Stable Value Fund are about $2.0 Billion. For the other state (let’s call it State ‘B’) the assets in the Custom Stable Value Fund are just over $1 Billion, or about half of the asset size of State ‘A’.

A few years ago, at the recommendation of their consultant, State ‘A’ converted from a “single-manager/single-wrap” to a “multi-manager/multi-wrap” arrangement. When the conversion was made, the total fees for the Custom Stable Value Fund maintained by State ‘A’ increased nearly three-fold. According to the fund summary the total fees for investment management, fund oversight, and administrative fees are approximately .44%. Fees are paid to multiple managers, multiple wrap providers, and a separate entity that oversees the “cash buffer” of the fund. The average yield for last year appears to be about 1.80% according to the plan web site.

Conversely, State ‘B’, which has a Custom Stable Value Fund that is half the size of State ‘A’ has total fees (investment management, book value wrapper, and administrative fee) of approximately .20%. The average yield for last year appears to be about 2.60% according to the plan web site.

Investment policy and other primary features are similar, yet the fees for the “multi” arrangement appear to be three times the cost of the “single” arrangement when investment management fees are compared side-by-side with administrative fees removed. To add to the irony, the fund with the higher fees is twice the size of the other fund, which would generally not be the case.

The pattern outlined above was similar for all of the funds examined. A large City and a large County in California (with different vendors and consultants) both converted from “single” to “multi” fund structure for their Custom Stable Value Funds at about the same time. In both situations, overall fees increased two to three times over the prior arrangement, and the net yield to participants plummeted. Other variables such as credit quality and investment policy were similar.

We could not find a single example where a conversion from “single” to “multi” designs lowered fees or improved yields.

The “Diversification” Argument

Consultants who advocate “multi” arrangements cannot argue with the fact that these arrangements are almost always more expensive and incredibly more complex to manage. However, they argue that there are benefits to diversification. If so, then what exactly are those benefits? Where is the data that show some future “benefit” of higher fees and lower yields? Some advocates of “multi’ arrangements speculate about fund-meltdown scenarios in which a “multi” wrap fund may have greater protection, but there are no actual facts of such situations to justify the higher fees. If one of your wrap providers fails, it makes little difference whether you have one wrapper or many – the fact is you have to replace the wrap provider who no longer meets your credit quality guidelines.

“Top of Scale” Fees

One of the most basic flaws of “multi” arrangements is the fact that plan participants lose the advantage of downscaling fees that nearly all fund managers offer. The more money you place with them, the lower your fees. So, when you hire five managers in place of one, you are at the top of the fee scale for all of those managers. That is one reason for the large increase in management fees in “multi” arrangements, and it is a disadvantage that does not go away.

Other Common Myths of the “Multi” Custom Stable Value Fund Design

  • Manager “Style” Specialty

 Managing bonds is not like managing stocks. Stocks are different, and different managers have different specialties. Bonds don’t have characteristics like stocks. Once you determine what percentage of your portfolio you want in AAA Corporates, or Government-backed securities, Treasuries, etc, nearly any large manager can go to the market and very efficiently purchase and manage your “basket” of bonds. Assuming your Investment Policy Statement for the Fund is clear, there’s not much room for “discretionary” choices like there are in stocks. The argument that a collection of bond managers can provide better selection and management than an overall manager is dubious when it comes to the size of the vast majority of Custom Stable Value funds. An exception would be in private placements, but this would not be a fund holding for the vast majority of Governmental defined contribution plans.

  •  “Wrapper” Diversification

Whether you have ten wrap providers or one, the main issue is credit quality and the ability to guarantee book value benefits. It’s easier to monitor and oversee one wrap provider than a variety, many of whom are small and have lesser credit quality than the larger firms. In one recent large plan that was out to bid, one of their wrap providers had already fallen below the minimum credit quality standards and was technically ineligible to be a wrap provider. This fact was pointed out by a potential bidder. Neither the consultant or plan sponsor was aware of that fact. These “multi” arrangements have many moving parts and require a higher level of oversight.

A Bummer for Retirees

 Retirees are still big users of Stable Value Funds. In once recent conversion from “single” to “multi” fund design, the fund yield dropped over .50% on the date of conversion due to higher fees investment management fees and a doubling of wrap fees. Retirees were understandably upset. When fixed yields are already at historic lows, a drop of .50% in yield can mean a big difference in draw-down income for retirees.

High Fees in a Low Interest Rate Environment

In a double-digit interest rate environment, a fee increase from .15% to .40% is not nearly as painful as the same increase in an interest rate environment where the gross yield is hovering around 2%-3%. In the current environment, every penny of fixed income yield makes a difference, so it is hard to justify the hefty fee increases in “multi” arrangements, regardless of the hypothetical arguments on diversification.

For huge Custom Stable Value Funds over $5 Billion, there are some scenarios where a dual or triple manager arrangement may make financial and investment sense. And, for some jumbo funds, one wrap provider may have a limit on the risk they will underwrite. But for the vast majority of Governmental Custom Stable Value Funds, the “multi” arrangements are just a bad deal for the participant, and a fee bonanza for the consultant.

Conflict of Interest Abounds

One of the more disturbing findings in our analysis is that in over half the situations examined, the consultant who recommended the “multi” design is also the manager of the new arrangement. A prudent plan sponsor should never permit that to happen. In a couple of situations, the consultant billings increased two fold after moving to a multi-manager/multi-wrap arrangement. In both situations, participants pay the consultant fees from fund revenue.

As we have discussed before, a plan sponsor should never permit a consultant to benefit from a recommendation he or she makes for a new product or service. To be certain your consultant is recommending a “multi” arrangement for the right reasons (if there really are any) be sure to tell them that they cannot be hired as a manager or provider for any services in any plan design or product structure they recommend.

For more information on this topic see the related article “Does Your Consultant Have a Conflict of Interest?”, February 5, 2014.

Not the Last Word…..

The debate on this issue will continue, of course. However, given the facts of high fees and falling yields in the market, “multi” arrangements will continue to be under pressure to justify this cumbersome and expensive fund design with no clear advantage for plan participants.  If rates continue to fall, it is conceivable that in some of the worst of these arrangements, the fees will outstrip the income to the point where the net yields drop below 1.00%.  The important question for the plan sponsor to ask is who really benefits from a conversion to a “multi-manager/multi-wrap” fund design, and who will suffer?

 

Gregory Seller Consulting, LLC

All rights reserved. May not be reprinted in whole or in part without written permission. Provided for information only and is not legal or investment advice. Plan sponsors should seek their own legal and investment advice on this issue.

 

 

 

[1] One exception being a Custom Stable Value Fund with over $10 billion in assets, for which a comparable fund was not examined.