Stable value fund
Stable value funds are capital preservation investment options available in 401(k) plans and other types of savings plans. The funds are comprised of high quality, diversified fixed income portfolios that are protected against interest rate volatility by contracts from banks and insurance companies. Stable value funds are designed to preserve capital while providing steady, positive returns. Stable value funds are conservative and are considered one of the lowest risk investment options offered in 401(k) plans.
The investment objective of stable value funds is to provide capital preservation and predictable steady, returns. During 2008, stable value funds were one of the few 401(k) investments that produced a positive return. Stable value fund returns generally ranged between 3 to 5 percent for 2008.
They have return stability similar to a money market fund but generate higher returns. The protection from interest rate volatility is universal and unique to stable value funds.
Stable value funds are offered in approximately half of all 401(k) plans and some 529 tuition savings plans. Individuals have invested $520 billion in stable value funds through 138,000 defined contribution plans, which include 457, 403(b) and 401(k) plans.
All investments have risks associated with them. Stable value funds are considered one of the lowest risk investments offered in 401(k) plans. Because of their low risk and stable, consistent returns they can help diversify 401(k) asset allocation.
Stable value funds are structured in two ways: as a separately managed account, which is a stable value fund managed for one specific 401(k) plan; or as a commingled fund, which pools together assets from many 401(k) plans. Commingled funds offer the benefits of diversification and economies of scale for smaller plans.
Regardless of how stable value funds are structured, they are comprised of a diversified portfolio of fixed income securities that are insulated from interest rate movements by contracts from banks and insurance companies. The protection from interest rate volatility is universal to stable value funds. How this contract protection is delivered depends on the type of stable value fund investment purchased. The contract protection against interest rate volatility is provided through the following investment instruments:
- Guaranteed Interest Contract (GIC)
- A contract with an insurance company that provides principal preservation and a specified rate of return over a set period of time, regardless of the performance of the underlying invested assets. The invested assets are owned by the insurance company and held within the insurer’s general account.
- Separate Account Contract
- An account held by an insurance company that holds a combination of fixed income securities and provides principal preservation and a specified rate of return over a set period of time. Separate accounts may provide either a fixed rate of return or a periodic rate of return based on the performance of the underlying assets. The assets are owned by the insurance company and are set aside in a separate account solely for the benefit of the specific contract holder.
- Synthetic GIC
- A diversified portfolio of fixed income securities that are insulated from interest rate volatility by contracts (wraps) from banks and insurance companies. In this arrangement, the 401(k) plan and its participants own the underlying invested assets-the portfolio of fixed income securities that support the stable value fund.
The typical stable value fund will diversify contract protection by investing in more than one instrument type and/or with more than one insurance company or bank.
- Default risk - Insurers which provide the contracts can go bankrupt. This risk is highest in funds using non-synthetic GICs. While most stable value funds attempt to diversify this risk by purchasing contracts from multiple insurers, the risk still exists (particularly since all the firms will be in the same industry--insurance).
- Interest rate lag - While book value accounting prevents NAV losses during rising rate periods, it equally prevents gains during falling rate periods.
- Liquidity risk - Because much of the stability of stable value funds is due to book value accounting, plans often limit withdrawals to certain time periods.
Stable value funds have multiple layers of government oversight. The vast majority of funds are regulated by the Department of Labor’s Employee Benefits Security Administration and must comply with the federal pension law, Employee Retirement Security Act (ERISA). Stable value funds in defined contribution plans for state and local governments- 457 plans-are regulated by the states, which have adopted requirements similar to ERISA.
In addition to the Department of Labor, stable value investment structures provided and/or managed by:
- banks are regulated by the Office of the Comptroller of Currency,
- insurance companies are regulated by the various state insurance departments, and
- commingled investment funds are regulated by the Securities and Exchange Commission under the Investment Company Act.
All stable value funds must comply with accounting regulations by the Financial Accounting Standards Board (FASB) (for corporate defined contribution plans) or the Governmental Accounting Standards Board (GASB) (for state and local defined contribution plans) to qualify for contract value accounting and reporting. Generally, FASB and GASB require that a stable value fund must meet all of the following criteria:
- the contract is effected directly between the fund and issuer and prohibits the sale or assignment of the contract or its proceeds to another party without the consent of the issuer;
- the repayment of principal and interest credited to participants in the fund is a financial obligation of the issuer of the contract. Prospective interest-crediting rate adjustments are permitted as long as they are not less than zero, and the contract issuer must be a financially sound institution;
- the terms of the contract require all permitted participant-initiated transactions with the fund to occur at contract value;
- an event that limits the ability of the fund to transact at contract value with the issuer and limits the ability of the fund to transact at contract value with participants in the fund must not be probable of occurring;
- the fund itself must allow participants reasonable access to their funds.
Role in a portfolio
While stable value funds generally do not contain bonds (except in the case of synthetic GICs), they are based on bonds, and their fixed income and low volatility make them ideally suited for the "bond" portion of a portfolio.
Be sure to check your employer's plan description regarding stable value funds, as there may be (normally) a 90 day transfer restriction with other accounts.
The intent of this restriction is to force investors to put their money "at risk" before taking advantage of the interest rate spread (difference) between the "stable" value rate and a short term rate of another fund, such as a Money Market fund.
Although both money Market Market and Stable Value funds attempt to maintain a stable asset value, the Stable Value funds invest farther along the yield curve and with the help of insurance contracts. The cost of liquidating these assets in an environment of rising interest rates is expensive to the fund and its remaining investors.
Other investment choices, such as short term and intermediate bond funds, make no pretense of maintaining a "stable net asset value". It is understood that these investments can and will lose money on a day to day basis and are therefore inappropriate for comparison with Stable Value funds.
- Stable Value FAQ, What Do You Need to Know about Stable Value Funds , from Stable Value Investment Association
- Forum discussion: is a stable value fund = short term bond fund?
- Forum discussion: Stable Value Funds within a 401(k) and transfer restrictions
- Prepare to Scrub - Even More Equity Wash, from Cobb Retirement Solutions (31-Jan-2011), suggestions for managing stable value funds in your 401(k)
- Bathing in Risk - the 90 Day Equity Wash, from Cobb Retirement Solutions
- The Downside of Up for Stable Value Funds, from Cobb Retirement Solutions
- Definitions of Stable Value Fund, on Google
- Stable Value Fund, from Investopedia
- The Safe Haven in Your 401(k), CBS Moneywatch.com
- Guaranteed Investment Contract, from Investopedia
- Stable value: Navigating past the 2008 credit crisis, Vanguard Research, March 2011. Appendix B (page 18) contains a comparison table for stable value, money market, short-term bond, and intermediate-term bond funds.
- Babbel, David F. and Herce, Miguel, A Closer Look at Stable Value Funds Performance, (September 18, 2007). Wharton Financial Institutions Center Working Paper No. 07-21. Available at SSRN.
- Babbel, David F. and Herce, Miguel, Stable Value Funds: Performance from 1973 Through 2008, (September 12, 2009). Available at SSRN.
- Babbel, David F. and Herce, Miguel, Stable Value Funds: Performance to Date (January 1, 2011), Available at SSRN.