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Stable Value - A Relative Value Discipline (pg 2/2)

Most wrap writers understand the above risks so they put constraints on the duration assumptions that may be used in their crediting rates. These constraints become much tighter in non-participating contracts where the wrap writer, and not the plan sponsor, assumes the withdrawal risks. Lastly, manipulation of crediting rates exposes the plan sponsor to unnecessary fiduciary liability for having favored one group of participants at the expense of others.

The myth: Synthetics are safer than GICs so a 100% synthetic portfolio is therefore the safest.

The facts: There is no free lunch. Synthetics, while capable of being constructed to reduce default risk to virtually zero, extract the price for safety in other ways. If safety were the only goal, every stable value fund would be comprised of treasuries wrapped by a AAA issuer in a non-participating synthetic structure. Imagine how poor the performance would be! Moreover, as many funds discovered with early investments in wrapped mortgage backed securities, which were used to maintain yield and increase overall credit quality, new risks took the place of credit risk. Greater call risk and interest rate risk dramatically affected yields and portfolio liquidity. When a portfolio needs more liquidity than is available in its STIF or through laddered maturities, (as with the current bull run) accessing synthetics that are under water further depresses portfolio yields. A synthetic under water is not technically as illiquid as an impaired GIC, but it can have a very similar feel.

Rather than eliminating one set of risks entirely in favor of another, FCM advocates the complementary use of both GICs and synthetics. In order to attain safety, liquidity and yield - diversify, diversify, diversify! In addition to their yield advantage and the benefits of a laddered series of contracts, GICs offer a unique source of liquidity since, unlike bonds, duration neutral restructures and early maturities at book value can often be negotiated with no change in rate. Synthetics offer great opportunities for broad sector diversification, reductions in concentration risks and diversification of the sources of portfolio yield. The key is understanding how to construct a portfolio using all available fixed income investments which meets the individual needs and risk tolerances of each plan sponsor.

pg. 2/2