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Stable Value - A Relative Value Discipline

In its ten year history, FCM has evolved with the 401(k) marketplace from a purely traditional GIC manager to a stable value manager employing a spectrum of complementary products to achieve stable value goals. A growing variety of synthetics are available to add value in attaining a stable value fund's goals: preservation of principal, attainment of competitive returns within acceptable risk tolerances, and liquidity. Most of the stable value industry has moved beyond the GIC versus synthetic posture that was evident for a time as firms recognize that product differences can complement one another to result in a more broadly diversified portfolio.

A stable value fund can be prudently invested exclusively in synthetics, however some staunch advocates base their decision to exclude GICs on myths which recognize only the strengths of synthetics ignoring their weaknesses and only the weaknesses of GICs ignoring their strengths.

The myth: After all costs, an actively managed bond portfolio will, on average, out perform a comparable duration GIC portfolio.

The facts: Our research has found this not to be true. As compared to FCM and the Ryan G5, a 2.5 year duration GIC benchmark, nearly all fixed income managers of

comparable portfolios underperform by a significant margin. The performance advantage is even greater after deductions for fees which are higher for bond portfolios and higher still after the addition of wrap fees.There are a number of reasons why this is true. First, active bond managers make decisions based upon their chosen style. Cyclical success results from individual firm competence coupled with the cyclical success of its style. Historically, even the most successful active managers are in the top quartile of performance for less than half the time frames measured. A laddered portfolio of GICs can be likened to an index fund which relies significantly upon the asset class for its yield rather than the success of interest rate and style bets. FCM's composite has had a high percentage of GICs over its history and the solid, long term performance reflects it.

GICs should offer attractive spreads in order to pay an investor for the risk of a relatively less diversified, less liquid investment. GICs can further add yield to a portfolio when the individual GICs are purchased in a competitive bidding process. Frequently a portfolio can buy the highest yield from among the strongest credits - an inefficiency that is common with GICs, but rare with bonds.

The myth: Managed synthetics are superior since the plan sponsor can manipulate the crediting rate to better track interest rates.

The facts: It is true that adjusting the duration used in the crediting rate formula can move the crediting rate more quickly in the direction of current interest rates. Lengthening the duration over which capital losses are amortized will slow the decline of the crediting rate and conversely, shortening the duration to accelerate the recognition of gains will keep the crediting rate more attractive. Problems arise in a participating synthetic if withdrawals are required from the contract. Participants making withdrawals or remaining in the fund will experience an "exaggerated" gain or loss. As those gains/losses are reflected in the next rate reset, the rate will exhibit more volatility than it would if a more consistent duration assumption were used (i.e. duration of the benchmark to which the assets are managed). Responsiveness to future interest rates will deteriorate as the amortization of "exaggerated" gains and losses are amortized.

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