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FIDELITY INSTITUTIONAL INSIGHTS Stable Value for Capital Preservation and Diversification Stable value strategies offer principal preservation and competitive income that have the potential to outpace inflation, with limited volatility.

David DeBiase, CFA KEY TAKEAWAYS Portfolio Manager • Stable value strategies are conservative retirement that have performed well relative to other principal preservation strategies in varying Robert Galusza market and environments.* Fixed Income Portfolio Manager • Historically, stable value strategies have provided attractive diversification benefits in 401(k) plans, and have generally generated yields that have outpaced inflation.* Julian R. Potenza, CFA • In uncertain interest rate environments, stable value strategies can be appealing Fixed Income Portfolio Manager because of their short duration and potential for steady returns. • Plan sponsors should be aware of the unique construction of stable value Sean Walker strategies and portfolio management considerations. Institutional Fixed Income Portfolio Manager

* See Exhibits 1 and 2. Past performance is no guarantee of future results. Millions of defined contribution (DC) plan participants are preparing for retirement—one of the largest groups of retirees leaving the workforce at the same time in history—as interest rates remain historically low. The need for principal preservation and ample income that can outpace inflation has thus remained top of mind for them. In this shifting environment, many plan sponsors are reviewing their capital preservation strategies, including stable value options, to help their retirees meet savings and income needs. In this paper, Fidelity outlines the key features and benefits of stable value strategies and how they behave relative to money market funds and inflation over the long term. The article also explains the unique construction of stable value strategies, discusses portfolio management considerations, and defines key terms to help plan sponsors in their due diligence.

Stable value strategies: What they are, and their key benefits Stable value strategies are capital preservation investments (typically separate accounts or commingled vehicles) available in 401(k)s and other retirement savings plans. They seek to provide steady, positive income and principal preservation. They invest in high-quality, fixed income securities to provide income, combined with book value “wrap” contracts. The wrap contracts allow plan participants to invest and redeem at book value under most circumstances, which lessens participants’ daily exposure to interest rate volatility. The unique structure of stable value strategies has allowed them to offer competitive returns, but with less daily rate sensitivity than high-quality alternatives such as money market funds and shorter-term funds (Exhibit 1).

EXHIBIT 1: Stable value strategies have had low return volatility over time Monthly returns, June 1999–March 2021 n Shorter-Term Bonds n Stable Value Strategies n Money Market Funds

Monthly Returns

2.0%

1.0%

0%

-1.0%

-2.0% 6/11 6/17 6/14 6/16 6/19 3/21 6/12 6/13 6/15 6/18 6/10 6/01 6/20 6/07 6/02 6/03 6/06 6/09 6/05 6/04 6/08 6/99 6/00

Source: Fidelity Investments, iMoneyNet, and Bloomberg Finance LP, as of March 31, 2021. Short-term bonds represented by the monthly market value returns of the Bloomberg Barclays Stable Income Index. Stable value strategy returns represented by the monthly book value returns of the Bloomberg Barclays Stable Income Index. Money market monthly returns represented by the iMoneyNet Money Fund Average™. See endnotes for definitions. Note: The start date of June 30, 1999, represents the inception of the stable value index. Past performance is no guarantee of future results.

Stable Value for Capital Preservation and Diversification | 2 EXHIBIT 2: Stable value yields have exceeded money market yields and inflation in most environments n Stable Value Strategies n Money Market Funds n Inflation n Average Inflation

8% Average Stable Value Strategies 3.52% Money Market Funds 1.51% 6% Inflation 1.98%

4%

2%

0% 6/11 3/21 6/17 6/13 6/14 6/19 6/20 6/12 6/16 6/15 6/18 6/10 6/01 6/07 6/02 6/03 6/09 6/05 6/06 6/99 6/04 6/08 6/00

Source: Fidelity Investments, Bloomberg Finance LP, iMoneyNet, as of March 31, 2021. Stable value yields represented by the Bloomberg Barclays Stable Income Index crediting rate. yields represented by the iMoneyNet Money Fund Average™. Inflation represented by core average, year-over-year Consumer Price Index. See endnotes for definitions. It is not possible to invest in an index. Note: The start date of June 30, 1999, represents the inception of the stable value index. Past performance is no guarantee of future results.

Another appealing feature of stable value options is their history of exceeding both money market fund yields and inflation over long time periods (Exhibit 2). Stable value strategies outperformed money market funds largely due to their underlying investments’ longer duration. Although stable value does not have an explicit objective of beating inflation, the on a diversified portfolio of short-duration fixed income investments can achieve that objective in most market environments. For , this may provide an attractive income stream that can keep up with cost-of-living changes over long time periods, thereby preserving their purchasing power.

Attractive diversification benefits for 401(k) plans A third potential benefit is that stable value strategies have a low or negative correlation to many other asset classes that are offered within A correlation of -1 means that two DC plans (Exhibit 3). Correlation helps to assess portfolio diversification assets move in equal but opposite and is the degree to which two or more investments move together directions (when one goes up, the (positive correlation) or in opposition (negative correlation) over time. As other goes down). A correlation of seen in Exhibit 3, stable value strategies are negatively correlated to U.S. +1 means the two securities move large and small cap stocks and developed international stocks, and have in lockstep in the same direction. a low correlation to -grade bonds. Given that stock and bond Zero correlation means the two fund prices may move sharply at times due to market influences, a stable securities move randomly with value strategy can provide participants with the potential for enhanced respect to each other. portfolio diversification and risk-adjusted returns.

Stable Value for Capital Preservation and Diversification | 3 EXHIBIT 3: Stable value strategies have a low or negative correlation to many plan options Historical performance correlations, June 1999–March 2021

Small Cap International Investment Stable Value U.S. Stocks Stocks Stocks Grade Bonds

Stable Value 1.00 –0.15 –0.07 –0.07 0.17

U.S. Stocks –0.15 1.00 0.84 0.87 –0.08

Small Cap Stocks –0.07 0.84 1.00 0.78 –0.11

International Stocks –0.07 0.87 0.78 1.00 0.00

Investment Grade Bonds 0.17 –0.08 –0.11 0.00 1.00

Source: Fidelity Investments, Bloomberg Finance LP, as of March 31, 2021. Stable value represented by the Bloomberg Barclays Stable Income Index. U.S. stocks represented by the S&P 500© index. Small cap stocks represented by the Russell 2000 Index. International stocks represented by the MSCI EAFE Index. Investment- grade bonds represented by the Bloomberg Barclays U.S. Aggregate Bond Index. See endnotes for definitions. It is not possible to invest in an index. Diversification does not guarantee a benefit or protect against a loss. Past performance is no guarantee of future results.

Portfolio construction: Features that help add value Several features of stable value strategies contribute to their reliable income and limited volatility, including the wrap structure, book value accounting, and duration management. Wrap structure: To generate their attractive combination of principal protection and competitive income potential, stable value strategies pair a high-quality portfolio of fixed income assets with some form of book value contract protection. Book value essentially refers to the stability of participants’ stable value balances, and this accounting feature is typically provided by a or company. In the early days of the industry, protection often took the form of a Guaranteed Investment Contract (GIC), with a single insurance company providing both the book value guarantee and the underlying investment(s). Over time, the industry has evolved from traditional GICs to sophisticated synthetic structures combining the potential benefits of an actively managed bond portfolio with a more diversified pool of wrap contracts. Synthetic stable value structures tend to offer greater transparency and diversification, with more favorable fees and termination provisions than bundled, insurance company investment contracts. Defined contribution plans also retain ownership of the underlying assets when combined with synthetic wrap contracts. A stable value manager not only must be skilled in managing the underlying fixed income portfolio but must also conduct due diligence and have deep relationships with wrap providers in order to negotiate the most favorable terms for a plan. Wrap providers in turn typically require stable value strategies to invest in investment- grade securities, and they utilize sector allocation constraints to ensure portfolio diversification—additional steps that help to support risk mitigation.

Stable Value for Capital Preservation and Diversification | 4 Money Markets vs. Stable Value While stable value strategies have many unique benefits, plan sponsors should understand important differences from traditional money market funds in selecting capital preservation options for their plan lineups. Both may merit consideration for participants’ portfolios, and indeed a growing number of plans are offering both in their lineups, according to data from Fidelity’s platform (Exhibit 4).

EXHIBIT 4: Usage of money market funds and stable value funds at DC plans

DC Plan Trends—Stable Value and Money Market Funds 2017 2019 2021

% offering money markets (overall) 78.1% 77.9% 79.6%

% offering stable value (overall) 38.0% 40.2% 41.2%

% offering only money markets 60.5% 57.5% 55.7%

% offering only stable value 21.7% 21.9% 20.2%

% offering both 17.6% 20.4% 23.9% As of March 31, 2021.

Money market funds hold instruments with a weighted average maturity (WAM) of 60 days or less, while stable value strategies typically invest in securities with maturities of approximately 1–5 years with accompanying interest rate and credit risk. Money market funds are often used for more immediate liquidity needs, or within a plan, operate as a temporary holding spot when an is changing allocations. Stable value liquidity, on the other hand, is governed by the terms of the plan and the contracts. Participants may tend to hold stable value strategies for longer periods to provide them with similar principal protection plus the potential for more capital accumulation over time. Because stable value is only offered within defined contribution employee benefit plans, a stable value option may also encourage pre-retirees and retirees to stay in plan rather than cash out their portfolios. The number of plans offering stable value strategies alongside traditional money market funds has been rising in recent years, according to Fidelity data. As of March 31, 2021, about 5.6% of DC plan assets on the Fidelity platform are in stable value strategies, compared with 1.6% in money market funds.

You could lose money by investing in a money market fund. An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Before investing, always read a money market fund’s prospectus for policies specific to that fund.

Stable Value for Capital Preservation and Diversification | 5 Book value accounting: While the underlying fixed income securities within stable value strategies are typically high quality and very liquid, they do experience price volatility driven by changes in market variables, including interest rates and credit spreads. Participant balances are “stabilized” by book value accounting that amortizes unrealized gains and losses in the underlying holdings via a crediting rate (yield) that is passed on to participants (Exhibit 5). When a stable value strategy’s market value is below its book value, its crediting rate will be lower than the yield of the underlying portfolio until enough time passes for it to recover. When the strategy’s market value is above its book value, its crediting rate will be higher than the portfolio’s yield until enough time passes for the gains to be distributed to participants. The market value to book value ratio, or MV/BV ratio, is a key risk management metric used to assess a stable value strategy’s health. Lower MV/BV volatility reduces the impact on crediting rates when there are participant flows. Duration management: Duration management refers to how portfolio managers manage the interest rate risk of their fixed income portfolios. Stable value strategies with shorter durations are less likely than longer-duration portfolios to experience downward pressure on their MV/BV ratios in a rising rate environment. This is because rising interest rates generally cause the market value of the underlying securities to decline. Managers who take on more risk and reach for yield during low-rate periods may face more significant MV/BV deficits when rates normalize. Stable value strategies with lower MV/BV ratios may also have challenges in obtaining wrap capacity, because wrap providers may be less willing to approve the portfolio for wrap coverage. A prudent manager takes a balanced approach to generating yield and managing MV/BV volatility.

EXHIBIT 5: Book value accounting helps allow stable value assets to grow at a more constant rate n Book Value n Market Value

Market value of underlying securities

Falling interest rates Asset Value

Rising interest rates

Time

Source: Stable Value Investment Association. For illustrative purposes only.

Stable Value for Capital Preservation and Diversification | 6 Stable value through interest rate cycles Principal preservation strategies are influenced by factors such as policy, the path of short-term interest rates, and periods of market volatility. However, a stable value strategy with prudent duration and yield management, managed by an asset manager with strong relationships with wrap providers, has the potential to offer higher returns over the long term than other principal preservation strategies. A well-managed stable value strategy can therefore mitigate the impact of lower interest rates and other bond market shocks as seen in the beginning of 2020 due to the COVID-19 virus. This track record suggests stable value is a compelling capital preservation option for many long-term investors in DC plans. Consider this hypothetical scenario designed to replicate challenging bond market conditions, with a 100 basis point (bps) interest-rate increase over a 12-month period. (Exhibit 6).

EXHIBIT 6: Hypothetical example: Prudent duration management can help stable value strategies weather interest rate increases Impact of hypothetical 100-bps interest rate increase to the MV/BV ratio and crediting rate

n MV/BV ratio (Left Axis) n Crediting Rate (Right Axis) Assumptions* Duration 2.86 years Yield 0.73% 102.5% 2.0% assumes a 100-bps interest rate increase

101.5% 1.5%

100.5% 1.0%

99.5%

0.5% 98.5%

97.5% 0.0% 0 10 20 30 40 50 60 70 80 90 100 Month

Source: Fidelity Investments, Bloomberg Finance LP, as of March 31, 2021. Hypothetical example for illustrative purposes only. Not meant to imply the actual performance of any product. * Model assumptions: starting MV/BV ratio of 102.21%; Bloomberg Barclays Stable Income Index duration 2.86 years and yield of 0.73% as of March 31, 2021. Assumes a 100-bps rate hike over the first 12 months but no additional increases during the ensuing 88 months. Past performance is no guarantee of future results.

Stable Value for Capital Preservation and Diversification | 7 After the 100 bps rate increase in 12 months, the MV/BV ratio of a hypothetical wrapped bond portfolio declines from 102.21% to 99.08%, reducing the crediting rate in the short term. However, the higher yields in the underlying securities gradually boost the crediting rate to 1.70%.

Conclusion With one of the largest cohorts of retirees in history planning to leave the workforce, income and principal preservation will remain top of mind for plan sponsors and their participants. As a conservative option that has stood the test of time through varying environments, a properly constructed stable value strategy—that prudently manages selection, duration, and yield while maintaining strong relationships with wrap providers—can be a cornerstone of DC plans.

For plan sponsor and investment professional use only. Not intended for use with plan participants. This document does not make an offer or solicitation to buy or sell any securities or services, and is not investment advice. FIAM does not provide legal or tax advice and we encourage you to consult your own lawyer, accountant, or other advisor before making an investment. Information provided in this document is for informational and educational purposes only. To the extent any investment information in this material is deemed to be a recommendation, it is not meant to be impartial investment advice or advice in a fiduciary capacity and is not intended to be used as a primary basis for you or your client’s investment decisions. Fidelity and its representatives may have a conflict of interest in the products or services mentioned in this material because they have a financial interest in them, and receive compensation, directly or indirectly, in connection with the management, distribution, and/or servicing of these products or services, including Fidelity funds, certain third-party funds and products, and certain investment services. Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. Views expressed are as of June 15, 2021, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information. Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk. Nothing in this content should be considered to be legal or tax advice and you are encouraged to consult your own lawyer, accountant, or other advisor before making any financial decision. Past performance is no guarantee of future results. Neither asset allocation nor diversification ensures a profit or guarantees against a loss. In general the bond market is volatile in varying degrees. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible. Duration estimates how much a bond’s price fluctuates with changes in comparable interest rates. Other factors can also influence a ’s performance and share price. Stable value funds have protection against interest rate swings via the book value commitments in insurance company and bank contracts. This means that participant investors in a stable value fund are able to transact (make deposits, withdrawals, and transfers) at book or contract value, which is principal plus accrued interest. If the market value of the stable value fund’s underlying assets is insufficient to honor benefits for covered withdrawals at book value, then the contractual protections kick in to ensure that participants continue to transact at contract value. Contract value, or book value, is the value of all the assets supporting the stable value fund plus the contractual protection against interest rate volatility.

Stable Value for Capital Preservation and Diversification | 8 Author The duration of a bond is the estimated percentage increase in price for a one percentage point fall in interest rates. A bond with a duration of 10 will likely rise roughly 10% in price when interest David DeBiase, CFA rates drop by one percentage point. Based on a related concept, duration can be thought of as the Fixed Income Portfolio Manager weighted average time, in years, until a security’s cash flows are received. Shorter-term bonds represented by the monthly market value returns of the Bloomberg Barclays Dave DeBiase manages Fidelity and Fidelity Stable Income Index. Stable value strategy returns represented by the monthly book value Advisor bond funds, as well as stable value and returns of the Bloomberg Barclays Stable Income Index. Stable value yields represented by the various institutional portfolios. Bloomberg Barclays Stable Income Index crediting rate. Money market monthly returns and yields represented by the iMoneyNet Money Fund Average™. Inflation represented by core average, Robert Galusza year-over-year Consumer Price Index. U.S. stocks represented by the S&P 500© index. Small cap stocks represented by the Russell Fixed Income Portfolio Manager 2000 Index. International stocks represented by the MSCI EAFE Index. Investment-grade bonds Rob Galusza co-manages Fidelity and Fidelity represented by the Bloomberg Barclays U.S. Aggregate Bond Index. Advisor bond mutual funds , as well as short It is not possible to invest directly in an index. duration portfolios for institutional clients. Index definitions The Consumer Price Index (CPI) measures over time the cost of goods and services purchased Julian R. Potenza, CFA by the consumer compared to a base period. The Bloomberg Barclays Stable Income Index was created as a benchmark for stable value funds, and includes government, credit, and securitized Fixed Income Portfolio Manager sectors of the Bloomberg Barclays U.S. Aggregate Bond Index. The Bloomberg Barclays U.S. Julian Potenza co-manages Fidelity bond funds Aggregate Bond Index is a broad-based, market value-weighted benchmark that measures the performance of the investment-grade, U.S. dollar-denominated, fixed-rate taxable bond market. and Fidelity stable value portfolios, as well as Sectors in the index include Treasuries, government-related and corporate securities, MBS short and intermediate duration portfolios for (agency fixed-rate and hybrid ARM pass-throughs), ABS, and CMBS.The iMoneyNet Money institutional clients. Fund Average™—Gov’t Institutional—Category includes all government institutional funds: Treasury Institutional, Treasury & Repo Institutional, and Government & Agencies Institutional. Sean Walker The iMoneyNet Money Fund Average™—the most widely recognized benchmarks for money market mutual funds are produced daily, weekly, monthly, and quarterly using a simple average of Institutional Fixed Income Portfolio Manager all fund yields and returns. The All Taxable and All Tax-Free Yield Averages are the most popular benchmarks for measuring fund performance. Daily averages produced include those for the Sean Walker is responsible for the development 1-Day Simple Yield, 7-Day Simple Yield, 7-Day Compound Yield, and 30-Day Simple Yield. Weekly and oversight of institutional Fixed Income averages produced include those for the 7-Day Yield, 7-Day Compound Yield, and 30-Day Simple investment strategies. Yield. Monthly averages include Monthly Yield, Monthly Total Return, 12-Month-to-Date Yield, 12-Month-to-Date Total Return, and Charged and Incurred Expense Ratios along with Gross Yields and Gross Returns. Quarterly averages are also available. S&P 500® index is a market Fidelity Thought Leadership Vice President capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry Martine Costello Duffy, provided editorial group representation to represent U.S. equity performance. Russell 2000 Index is a market direction for this article. capitalization-weighted index designed to measure the performance of the small cap segment of the U.S. equity market. It includes approximately 2,000 of the smallest securities in the Russell 3000 Index. Russell 3000 Index is a market capitalization-weighted index designed to measure the performance of the 3,000 largest companies in the U.S. equity market. MSCI EAFE Index is a market capitalization-weighted index that is designed to measure the investable equity market performance for global investors in developed markets, excluding the U.S. & Canada. The Chartered Financial Analyst (CFA) designation is offered by the CFA Institute. 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