1. The Future of Low-Risk Options Within
Defined Contribution Plans
©2003 – 2013 Multnomah Group, Inc. All Rights Reserved.

2. Scott Cameron, CFA
Scott is the Chief Investment Officer for the Multnomah Group and a Founding
Principal of the firm. In that role, Scott leads Multnomah Group’s Investment
Committee, is responsible for the development of the firm’s investment
research methodology, and conducts investment manager due diligence. Scott
also consults with plan sponsors on investment menu design, investment
manager selection, fiduciary governance, and vendor fees/services.
Prior to founding the Multnomah Group, Scott was an investment consultant
with a national retirement services firm.
Scott is a member of the CFA Institute, the CFA Society of Portland, the
Investment Management Consultants Association, and the Portland Chapter of
the Western Pension & Benefits Council. Scott holds a B.S in Management
from Purdue University.
2 The Future of Low-Risk Options Within Defined Contribution Plans

3. Agenda
• A History of Stable Value Funds
• Challenges Facing Stable Value Providers
• Changes in Money Market Fund Rules
• Other Options for Low Risk Investments
3 The Future of Low-Risk Options Within Defined Contribution Plans

4. Stable Value Facts
• $540 billion invested in stable value assets
• 127,000 defined contribution plans offer stable value vehicles
• Aon Hewitt 401(k) Index™ 2011 had stable value assets at 23.12% of 401(k)
plan assets
Source: SVIA 15th Annual Investment Policy Survey Covering Stable Value Assets as of year end 2010
4 The Future of Low-Risk Options Within Defined Contribution Plans

5. A History of Stable Value Funds
1980s 1990s
• Insurance company guaranteed • Executive Life Insurance Company
investment contracts (GICs) most failed in 1991
popular • Failure of large GIC issuer caused
• Backed by full faith and credit of insurance industry to transition to
issuing insurance company separate account GICs
• Assets invested in insurance • Similar to GIC but assets placed in
company general account a separate accounts
• Earn stated interest rate declared • Synthetic GICs began to develop as
by insurance company well
• Insurance company earned • Assets owned by a plan / trust
“spread” – difference between the • Guarantee function provided by a
return on general account assets “wrap contract’ provided by a bank
and the crediting rate paid out to or insurance company
contract holders
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6. A History of Stable Value Funds (cont.)
• 2000s 2008 – Present
• Fixed income management evolved • Credit crisis froze credit markets
within synthetic GICs and pushed bond spreads to
• Use fixed income portfolios instead historically wide levels
of single bonds
• Widening spreads caused market
• Allowed for the use of outside sub- value to book value (MV / BV) ratios
advisors
to fall into the low 90% range
• Synthetic GICs become more
• Underwater stable value funds
prevalent than traditional GICs or
increased likelihood that wrap
separate account GICs
providers would have to make good
• Wrap contract pricing decreased to on their guarantees
mid single digit basis points (6-8
• Some wrap insurers elect to get out
bps)
of the business, putting pressure on
stable value managers
6 The Future of Low-Risk Options Within Defined Contribution Plans

7. Synthetic GIC Stable Value Structure
• Objective: Capital preservation coupled with steady, positive returns
• Expected to provide a return premium to money market funds because of
the ability to accept greater interest rate and credit risk
• Synthetic GIC stable value funds consist of short / intermediate duration,
high credit quality bond portfolio
• Bond portfolio is “wrapped” with contracts from wrap issuers (banks or
insurance companies) that enable participants to transact at book value
• Wrap contracts do not protect against credit losses
• Investment returns and gains / losses are smoothed using a formula to
maintain stable book value
• Structured as a separate or pooled account (collective investment trust)
• Separate accounts are for large plan sponsors (single plan)
• Pooled accounts consist of many (sometimes thousands) of smaller plan
sponsors
7 The Future of Low-Risk Options Within Defined Contribution Plans

8. Stable Value Funds Today
• Wrap capacity is tight
• Cost of wrap contracts increased to
20-25 bps
• Wrap providers worried about
mismatch in duration (12 month put
vs. 3 year duration) Stable Value
Wrap Issuers
Providers
• Wrap providers existing business
• Rabobank
• Bank of America
• JP Morgan
• AIG (maybe)
• Stable value providers exiting
business
• Bank of America
• State Street
• Deutsche Bank
• Schwab
8 The Future of Low-Risk Options Within Defined Contribution Plans

9. Stable Value Funds in the Future
• Consolidation of stable value providers
• Higher costs / lower capacity will continue to squeeze providers
• More expensive wrap insurance will bring new entrants into the market
• Low interest rate environment
• Improved MV / BV ratios
• Stable value funds have only existed during a period of steady, declining interest
rates
• Increasing rate environment will put pressure on MV / BV ratios
• May also cause higher levels of participant transactions as participants try to
arbitrage return differentials
• Money market funds react more quickly to yield changes (may outperform stable
value for a period of time)
• Back to the future
• Use of more traditional GICs / separate account GICs with synthetic GICs
portfolios
• Bundling of wrap insurance with investment management
• Increased usage of traditional GICs and separate account GICs by plan
sponsors
9 The Future of Low-Risk Options Within Defined Contribution Plans

10. Replacement Options
Option Option Option Option
1 2 3 4
Money Money Money
Replacement Market Market Market
Stable Value
Fund
Short Term Short Term
Ultra Short
Government Bond
Term Bond
Bond
Intermediate
Bond Intermediate Intermediate Intermediate
Bond Bond Bond
10 The Future of Low-Risk Options Within Defined Contribution Plans

11. Investment Product Characteristics
Money Market
• Targeted stable Net Asset Value (NAV)
• Regulated by SEC Rule 2a-7 (Revised in Jan. 2010)
• Mandates liquidity minimums
• 10% liquid within 1 day
• 30% liquid within 1 week
• Maximum 5% in illiquid securities
• Higher credit quality
• Maximum 3% limit on Second Tier securities
• Maximum 0.5% limit on single issuer Second Tier securities
• Maximum maturity of 45 days for Second Tier securities
• Shorter maturity limits
• Maximum weighted average life of 120 days
• Maximum weighted average maturity of 60 days
• Requires periodic stress tests
• Enhanced disclosures
11 The Future of Low-Risk Options Within Defined Contribution Plans

12. Investment Products Characteristics (cont.)
Ultra Short Term Bond
“Ultrashort-bond portfolios invest primarilty in investment-grade U.S. fixed-
income issues and have durations typically of less than one year. This category
can include corporate or government ultrashort bond portfolios, but it excludes
internation, covertible, multisector, and high-yield bond portfolios. Because of
their focus on bonds with very short durations, these portfolios offer minimum
interest-rate sensitivity and therefore low risk and total return potential.” –
Morningstar
• Category Average Statistics (Morningstar)
• Average Effective Duration – 0.41
• Average Effective Maturity – 0.94
• Average Credit Quality - A
12 The Future of Low-Risk Options Within Defined Contribution Plans

13. Investment Product Characteristics (cont.)
Short Government Bond
“Short-government portfolios have at least 90% of their bond holdings in bonds
backed by the U.S. government or by government-linked agencies. This
backing minimizes the credit risk of these portfolios, as the U.S. government is
unlikely to default on its debt. These portfolios have durations typically between
1.0 and 3.5 years, so they have relatively less sensitivity to interest rates, and,
thus, low risk potential.” – Morningstar
• Category Average Statistics (Morninstar)
• Average Effective Duration – 1.88
• Average Effective Maturity – 2.55
• Average Credit Quality – AA
13 The Future of Low-Risk Options Within Defined Contribution Plans

14. Investment Product Characteristics (cont.)
Short Bond
“Short-term bond portfolios invest primarily in corporate and other investment-
grade U.S. fixed-income issues and typically have durations of 1.0 to 3.5 years.
These portfolios are attractive to fairly conservative investors, because they are
less sensitive to interest rates than portfolios with longer durations.” –
Morningstar
• Category Average Statistics (Morningstar)
• Average Effective Duration – 2.17
• Average Effective Maturity – 2.79
• Average Credit Quality – A
14 The Future of Low-Risk Options Within Defined Contribution Plans

15. Historical Performance
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16. Disclosures
Multnomah Group, Inc. is an Oregon corporation and SEC registered investment
adviser.
Investment performance and returns are based on historical information and are not
a guarantee of future performance. Investing contains risk. Some asset classes
involve significantly higher risk because of the nature of the investments and the
low liquidity/high volatility of the securities.
Any information and materials contained herein or on our website are provided for
general informational purposes only and are not intended to be comprehensive for
any particular subject. Multnomah Group utilizes information from third party
sources believed to be reliable but not guaranteed, and as a result, information is
provided to you "as is." We do not represent, guarantee, or provide any warranties
(either express or implied) regarding the completeness, accuracy, or currency of
information or its suitability for any particular purpose. Multnomah Group shall not
be liable to you or any third party resulting from any use or misuse of information
provided.
Receipt of information or materials provided herein or on our website does not
create an adviser-client relationship between Multnomah Group and you.
Multnomah Group does not provide tax or legal advice or opinions. You should
consult with your own tax or legal adviser for advice about your specific situation.
16 The Future of Low-Risk Options Within Defined Contribution Plans