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Asking the Right Questions — a Fiduciary Responsibility

Sovereign debt (Greek and others) continues to plague financial markets.  My last few posts have tried to illustrate that these are not abstract issues, but can have real impact on money market funds, securities lending and stable value programs.  Fiduciaries must understand these implications.

Today the NYTimes reports that many money market funds have been paring back their exposure to european bank debt.  Wary Investors Shun European Banks.  As explained in the article,  European Banks rely heavily on short term funding provided by U.S. money market funds.   And, let’s not forget that most US investors turn to money markets as safe investments.

Not surprising, there is a wide spectrum of investment views on european sovereign and bank debt.  The Times points out these different views and, these differing views make markets. Again, no surprises here.

When asked about money market funds’ exposure to european debt, Deborah Cunningham, a senior portfolio manager at Federated Investments commented, “We’re always rethinking it and assessing it, but we’ve not come up with a different answer,” she said. “We don’t feel there’s any jeopardy with regard to repayment.”

Similarly, a spokesman from Fidelity Invetments, Adam Banker explained, “We’re very comfortable with our money market funds’ European bank holdings, including French bank holdings.”

Both Federated and Fidelity are huge players in the 401(k) retirement arena.   The article reports that they manage $114 billion and $428 billion, respectively in money market funds (note, the article was explicit about the Federated money market assets under management, where as the Fidelity number was not specifically identified as money market assests. However, Fidelity reports that it currently manages $1.5 trillion of assets, so it is reasonable to assume that $428 billion is held by money market funds).

The real point is that Federated and Fidelity collectively manage more than $500 billion in money money market funds.  Thousands of plan participants are relying upon their judgment with respect to the safety and security of the participants retirement assets.

The volatility of financial markets these days is historically very high.  In large part due to questions raised by European Debt.

Fidelity and Federated must do better than “we’re very comfortable”  or “we don’t feel there’s any jeopardy … “.  Those are nice quotes for a NYT article.  But for fiduciaries these quotes should constitute red flags.  If we have learned nothing else from the financial crisis, bland statements issued by corporate spokespeople have the potential to hide serious issues.  According to the Times article, Federated has about 13 to 17 percent of assets … invested in French bank debt”.   That is not insubstantial.  It begs further explanation.

For any Plan Sponsor whose retirement plans offer Fidelity or Federated money market funds, pick up the phone today.  Just ask a few basic questions.  Remember, other smart investment professionals are not comfortable.  They in fact see potential jeopardy ahead. Fidelity and Federated must explain their positions.  Here’s a few questions for starters:

  • Why are you comfortable?
  • Why isn’t there any jeopardy?
  • How did you analyze your investment positions to reach this conclusion?
  • What assumptions did you make?
  • What are the weakest points in your analysis.

As if often the case …. a few open ended questions can spark a very enlightening discussion.

Plan fiduciaries have an obligation to ask these questions and assess the reasonableness of the responses.

Rarely would I turn to Ronald Regan for wisdom, but here goes,  ”Trust, but verify.”

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Simple & Risk Free?  Hardly.

Plan participants have flocked to Stable Value programs to the tune of $700+ billion. As the name implies,  and most investors believe, these programs are touted as safe investment options for plan participants.  Maybe yes, maybe no.

Offering investment yields greater than money market funds, without the volatility of bond funds, Stable Value programs are hybrid investment and insurance products.  An investment manager manages the underlying cash portfolio, and an insurance company or bank then guarantees (or wraps) the book value of the program.  In essence, the value of the fund is not suppose to go below $1/share.

Hybrid products, however,  offer complexity, and complexity presents risks.

In the current low interest rate environment, unique risks confront plan fiduciaries.

To date, stable value plans have generated a higher investment return than money market funds because they can invest in securities with longer durations, paying higher interest rates.  When interest rates turn higher, however, this benefit becomes a drag.  Money market funds are more nimble and can take advantage of the higher rates in a rising rate environment.

Since most Stable Value funds are “marketed” as higher return investment options, plan participants will be very surprised to learn that their Stable Value options may be paying returns less than money market funds.  Employees must be educated on the true risks and mechanics of Stable Value Funds.  Failure to educate employees properly can bring sizable fiduciary risks on the plan sponsor.

With interest rates so low, Fiduciaries must not only monitor an upturn in rates, but they must also track withdrawals from Stable Value programs.   If interest rates do not increase, participants undoubtedly will begin switching into investment options generating higher returns.  Whether this makes investment sense is irrelevant.

The wrap contracts (which guarantee the value of the stable value program) often contain covenants that require the Program to maintain a minimum number of participants or assets in the Program.  Falling below this threshold constitutes a breach of the wrap agreement, and would allow an insurance company to walk away from the guarantee.   This is a total disaster from the perspective of the plan fiduciaries.

The very name “Stable Value” lulls everyone — participants and fiduciaries, alike – into a false sense of security.   These are highly technical and complicated investment options that should be monitored, evaluated and negotiated by Stable Value experts.

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