Protecting portfolio assets against market downturns is a necessity for retirees and older workers on the cusp of retirement. That’s where stable value funds can help.
Offered in 80% of U.S. defined-contribution plans with assets over $900 billion, stable value funds may not be stylish or aggressive but they can provide some much-needed insulation from market upheaval.
What are stable value funds and what do they offer retirement savers? Here’s an inside look.
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What Are Stable Value Funds?
Stable value funds are a portfolio of bonds with an insurance guarantee.
“Stable value funds are most akin to money market funds,” said Robert W. Johnson, professor of finance at Heider College of Business at Creighton University in Omaha, Nebraska, in an email. They invest in high-quality fixed-income offerings, both government and corporate. They operate like any other bond fund with one exception. Investors are protected against any loss of capital or interest.”
However, that protection against loss comes at a price, known as the insurance cost.
“Returns on stable value funds are more like those on money market funds than on other bond funds,” Johnson noted. “Also, stable value funds are not insured or protected against loss by the U.S. government. This insurance is not akin to Securities Investor Protection Corp. or Federal Deposit Insurance Corp. guarantees.”
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A Protective Insurance Element
Unlike a money market fund, which invests in very short-maturity debt, a stable value fund invests in short- to intermediate-term bonds, generally with higher yields.
“These investments are wrapped or guaranteed by an insurance company contract, which provides a principal guarantee to plan participants,” said Henry Riter, senior plan advisor at Sentinel Group in Boston, in an email. “With these guarantees in place, participants are insulated from investment losses in the event of rising interest rates or credit events, which can cause a drop in the value of the underlying bond portfolio.”
Stable value funds have existed for over 40 years and gained popularity over time. Over the years, investors have become attracted to competitive returns that have historically exceeded those of money market funds, with a comparable level of risk and safety of principal. “This was particularly important in the years before the rapid interest rate increases of 2022 when money market yields were close to zero for an extended period of time,” Riter noted.
While stable value funds provide a return advantage when rates are stable or falling, they can be a disadvantage when they rise.
“Many stable value funds are yielding less than money markets because of high interest rate increases since early 2022,” Riter said. “Stable value fund providers must amortize the difference between the underlying portfolio’s book value and market value over time. When there are market value losses in the underlying portfolio due to rising interest rates, this amortization creates a drag on returns.”
Stable value funds are only available in defined-contribution retirement plans. “They are not an option for an IRA, brokerage account or other investors,” Riter said.
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The Pros and Cons of Stable Value Funds
Like any investable asset, stable value funds offer opportunity as well as risk.
Stable Value Fund Pros
— Guarantee factor. With stable-value funds, any portfolio contribution never loses value. That’s unlike a traditional bond portfolio that faces interest rate risk. “These funds usually have trading restrictions, so that they don’t have to sell a bond prematurely at a loss like what happened at Silicon Valley Bank,” said Lori Gross, an investment advisor at Outlook Financial Center in Troy, Ohio, in an email.
— Volatility avoidance. As the name suggests, stable value funds are stable regarding return and principal preservation, making them appropriate vehicles for risk-averse investors looking for low-volatility investments. “The insurance portion of the fund may help reinforce conservative investors’ fears of volatility in the market,” said Vincent Grosso, founder of investment advisory firm Pascack Capital in Hoboken, New Jersey, in an email.
— They’re diversified. Due to the fund’s fixed-income composition, investors looking for income, such as retirees, should consider stable value funds as part of their portfolio allocation.
“Stable value funds contain a negative equity correlation, which enables investors to use them as diversification in their portfolio allocation strategy,” Grosso said.
Stable Value Fund Cons
— Fees and charges. The cost of guaranteed insurance wrappers will eat into your profit margin, Gross said. For example, Fidelity Advisor’s stable value fund has an expense ratio of 0.7%. Annual fees of up to 1% are common.
— Lower relative returns. Although a significant benefit of stable value funds is predictable returns, the drawback is the returns are typically lower than investing in equities. “This may not be an issue if an investor determines the risk-reward of equities is not worth it for them because of a low-risk tolerance or other suitability factors,” Grosso explained.
— Inflation risk potential. Inflation risk is a factor you should consider before investing in stable value funds. “Due to lower returns, the fund may not be able to keep pace with inflation,” Grosso added. “This means an investor can lose purchasing power due to the decrease in value of their money.”
— High fees. “Because of their structure, stable value funds have additional fees paid to insurance companies to provide the ‘wrap’ or book value guarantee,” Riter noted. These additional charges, which can bring total fund fees to about 1% of invested assets annually, will increase the stable value fund’s fee level compared to other options. “These higher fees are inherent in their structure, but they should not deter a plan sponsor from offering a stable value fund or a participant from investing in it,” Riter said. “Over time, the stable value fund structure has served participants well compared to other conservative investment options.”
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Why a Stable Value Fund Belongs in Your Retirement Portfolio originally appeared on usnews.com
Update 03/21/24: This story was published at an earlier date and has been updated with new information.
