A stable value fund is a type of investment available in 401(k) plans and other

defined contribution plan A defined contribution (DC) plan is a type of retirement plan in which the employer, employee or both make contributions on a regular basis. Individual accounts are set up for participants and benefits are based on the amounts credited to these a ...

s as well as some 529 or tuition assistance plans. Stable value funds are often made available in these plans under a name that intends to describe the nature of the fund (such as ''capital preservation fund'', ''fixed-interest fund'', ''

capital accumulation Capital accumulation is the dynamic that motivates the pursuit of profit, involving the investment of money or any financial asset with the goal of increasing the initial monetary value of said asset as a financial return whether in the form ...

fund'', ''principal protection fund'', ''guaranteed fund'', ''preservation fund'', or ''income fund'' among others). They offer principal preservation, predictable returns, and a rate higher than similar options without proportionately increasing risk. The funds are structured in various ways, but in general they are composed of high quality, diversified

fixed income Fixed income refers to any type of investment under which the borrower or issuer is obliged to make payments of a fixed amount on a fixed schedule. For example, the borrower may have to pay interest at a fixed rate once a year and repay the pr ...

portfolios that are protected against interest rate volatility by contracts from

bank A bank is a financial institution that accepts Deposit account, deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital m ...

s and

insurance companies Insurance is a means of protection from financial loss in which, in exchange for a fee, a party agrees to compensate another party in the event of a certain loss, damage, or injury. It is a form of risk management, primarily used to protect ...

. For example, a stable value fund may hold highly rated government or corporate debt, asset-backed securities, residential and commercial mortgage-backed securities, and cash equivalents. Stable value funds are designed to preserve principal while providing steady, positive returns, and are considered one of the lowest risk investment options offered in 401(k) plans. Stable value funds have recently been returning an annualized average of 2.72% as of October 2014, higher than the 0.08% offered by money-market funds, and are offered in 165,000 retirement plans.

Explanation

The investment objective of stable value funds is to provide capital preservation and predictable, steady returns. During the

2008 financial crisis The 2008 financial crisis, also known as the global financial crisis (GFC), was a major worldwide financial crisis centered in the United States. The causes of the 2008 crisis included excessive speculation on housing values by both homeowners ...

, stable value funds were one of the few 401(k) investments that produced a positive return; stable value fund returns generally ranged between 3 and 5 percent for 2008. Stable value funds generally invest in high

credit rating A credit rating is an evaluation of the credit risk of a prospective debtor (an individual, a business, company or a government). It is the practice of predicting or forecasting the ability of a supposed debtor to pay back the debt or default. The ...

bonds, typically AAA and AA, and then “wrap” them with contracts issued by banks and insurance companies that help smooth out the returns of the underlying portfolio of bonds. The wrap protects the fund in times of market volatility by smoothing out the losses and gains of the underlying investments over the duration of the fund. Another popular stable value structure is the general account product which provides a fixed rate of return for a stated period backed by the full faith and credit of the insurance company and transfers investment risks to the insurer as well. Stable value funds have a level of risk and stability similar to that of money market funds but generate higher returns. Stable value funds are offered in approximately half of all 401(k) plans and some 529 tuition savings plans. Individuals have invested $770 billion in stable value funds through 165,000 defined contribution plans, which include 457,

403(b) In the United States, a 403(b) plan is a U.S. tax-advantaged retirement savings plan available for public education organizations, some non-profit employers (only Internal Revenue Code 501(c)(3) organizations), cooperative hospital service organiz ...

and 401(k) plans as of June 2015.

History

Stable value funds have been around since the inception of US

s in the 1970s. Initially they consisted of guaranteed investment contracts, or GICs, which were backed solely by the issuer's claims-paying ability. GICs are issued by

and guarantee principal invested plus a periodically-reset

interest rate An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, ...

for a specific duration. The primary concern plan sponsors had in regards to GICs was the lack of flexibility and ownership of

assets In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can b ...

, which was partly remedied with the creation of separate account GICs. Separate account GICs hold the assets of the plan in a separate account that cannot be used to settle claims against the insurer's general account. Then in mid-1988 a broader array of stable value funds began to be offered, including the now common synthetic GIC. A synthetic GIC is a contract for a separately managed portfolio of fixed securities that is owned by the plan, often referred to as a wrap because it wraps the portfolio and protects it against rate fluctuations. In 2007, the Department of Labor excluded stable-value funds from their list of qualified default investment alternatives (QDIAs), but allowed retirement plans using stable-value funds to "grandfather" their choice. Today, the most commonly used type of contract in stable value funds is the synthetic GIC and from 1999 through 2014 stable value funds averaged a total return of 4.35% with a

standard deviation In statistics, the standard deviation is a measure of the amount of variation of the values of a variable about its Expected value, mean. A low standard Deviation (statistics), deviation indicates that the values tend to be close to the mean ( ...

of 1.23%. For money-market funds, the average total return was 1.93% with a standard deviation of 2.08%; and for intermediate-term bonds, 4.82% and 3.15%.

Types of stable value funds

Stable value funds are structured in one of three ways: as a separately managed account, which is a stable value fund managed for one specific 401(k) plan; as a commingled fund, which pools together assets from many 401(k) plans and offers the benefits of diversification and economies of scale for smaller plans; or as a guaranteed insurance company account, which issues a group

annuity In investment, an annuity is a series of payments made at equal intervals based on a contract with a lump sum of money. Insurance companies are common annuity providers and are used by clients for things like retirement or death benefits. Examples ...

contract directly to the plan. Regardless of how stable value funds are structured, they are a diversified portfolio of fixed income securities that are insulated from interest rate movements by contracts from banks and insurance companies. How this contract protection is delivered depends on the type of stable value fund

investment Investment is traditionally defined as the "commitment of resources into something expected to gain value over time". If an investment involves money, then it can be defined as a "commitment of money to receive more money later". From a broade ...

purchased and is provided through one or more of the following investment instruments:

Guaranteed Investment Contract (GIC)/General Account Contract

A group annuity 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

A contract with an insurance company that provides principal preservation and a specified rate of return over a set period of time on an account that holds a combination of

securities A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...

. Separate accounts may provide either a fixed, indexed, or 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 or retirement plan.

Synthetic GIC

A contract with a bank or insurance company (commonly referred to as a wrap) that guarantees a

rate of return In finance, return is a profit on an investment. It comprises any change in value of the investment, and/or cash flows (or securities, or other investments) which the investor receives from that investment over a specified time period, such as i ...

for a portfolio of assets held in an external trust. The rate of return is reset periodically and is based on the actual performance of the underlying assets. The assets are owned by the participating plan or plans. 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. Stable value portfolio

managers Management (or managing) is the administration of organizations, whether businesses, nonprofit organizations, or a government bodies through business administration, nonprofit management, or the political science sub-field of public administr ...

also limit risk by holding a mix of maturities, such as intermediate-term bonds and short-term bonds generally with credit ratings of AAA or AA.

Risks

Stable value funds are considered one of the lowest risk investments offered in 401(k) plans; however, like any investment, they do have some

risks In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environ ...

, which include:

Interest Rate Lag

In rapidly changing rate environments the returns on stable value funds may change more slowly than those of the marketplace, including similar investments such as

money market fund A money market fund (also called a money market mutual fund) is an open-end mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are managed with the goal of maintaining a hig ...

s. However, stable value funds still tend to outperform investments such as money market funds over time.

Liquidity Risk

To prevent yield chasing, stable value funds generally contain “equity wash rules” limiting transfers to competing investments such as a

or short-term

bond fund A bond fund or debt fund is a fund that invests in bonds, or other debt securities. Bond funds can be contrasted with stock funds and money funds. Bond funds typically pay periodic dividends that include interest payments on the fund's underlyi ...

. Generally a participant must first place money in a

stock Stocks (also capital stock, or sometimes interchangeably, shares) consist of all the Share (finance), shares by which ownership of a corporation or company is divided. A single share of the stock means fractional ownership of the corporatio ...

or equity fund for at least 90 days, but cash withdrawals have no waiting periods.

Contract Issuer/Guarantor Risk

Contract issuers can become less financially stable. This risk is most pronounced in funds with non-synthetic GICs because a single

guarantor In finance, a surety , surety bond, or guaranty involves a promise by one party to assume responsibility for the debt obligation of a borrower if that borrower defaults. Usually, a surety bond or surety is a promise by a person or company (a ''sure ...

is backing the fund with the full faith and credit of the company. Most stable value funds mitigate this risk by purchasing contracts from multiple issuers, and stable value contract providers are generally strong

financial institutions A financial institution, sometimes called a banking institution, is a business entity that provides service as an intermediary for different types of financial monetary transactions. Broadly speaking, there are three major types of financial ins ...

Investor Cash Flows Affect Returns

An influx of money to a stable value fund during a period of low interest rates can result in more investments at the current rate, which may dilute returns for

investors An investor is a person who allocates financial capital with the expectation of a future return (profit) or to gain an advantage (interest). Through this allocated capital the investor usually purchases some species of property. Types of in ...

. However, the alternative is also true. Large inflows of money into a stable value fund when interest rates are high can alternatively increase returns. Most stable value funds include a cash buffer to pay out withdrawals and minimize cash flow effects so the stable value fund crediting rates remain stable and consistently positive.

Employer Initiated Events

Certain employer initiated events can limit the liability of contract issuers, potentially leaving investors with losses. Events such as major layoffs,

mergers Mergers and acquisitions (M&A) are business transactions in which the ownership of a company, business organization, or one of their operating units is transferred to or consolidated with another entity. They may happen through direct absorpt ...

, and

bankruptcy Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the deb ...

will typically invalidate the portfolio's contracts since they increase the possibility that an issuer would have to pay out on contracts for these management initiated events. Losses in such cases are rare, since most companies generally have enough time to negotiate continued coverage for the stable value fund. Many stable value funds have survived bankruptcies without any losses, for example in the case of

Enron Enron Corporation was an American Energy development, energy, Commodity, commodities, and services company based in Houston, Texas. It was led by Kenneth Lay and developed in 1985 via a merger between Houston Natural Gas and InterNorth, both re ...

in 2001.

Regulations

Stable value funds have multiple layers of government oversight. The vast majority of funds are regulated by the

Department of Labor A ministry of labour (''British English, UK''), or labor (''American English, US''), also known as a department of labour, or labor, is a government department responsible for setting labour standards, labour dispute mechanisms, employment, workfor ...

Employee Benefits Security Administration The Employee Benefits Security Administration (EBSA) is an agency of the United States Department of Labor responsible for administering, regulating and enforcing the provisions of Title I of the Employee Retirement Income Security Act of 1974 ...

and must comply with the federal pension law, the

Employee Retirement Income Security Act The Employee Retirement Income Security Act of 1974 (ERISA) (, codified in part at ) is a U.S. federal tax and labor law that establishes minimum standards for pension plans in private industry. It contains rules on the federal income tax e ...

(ERISA). Stable value funds in defined contribution plans for state and local governments (

457 plan The 457 plan is a type of nonqualified, tax advantaged deferred-compensation retirement plan that is available for governmental and certain nongovernmental employers in the United States. The employer provides the plan and the employee defers co ...

s) 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 and/or the

Federal Reserve The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a series of ...

. Stable value funds offered by insurance companies are regulated by the various state insurance departments, and commingled investment funds are regulated by the

Securities and Exchange Commission The United States Securities and Exchange Commission (SEC) is an independent agency of the United States federal government, created in the aftermath of the Wall Street crash of 1929. Its primary purpose is to enforce laws against market m ...

under the Investment Company Act. All stable value funds must comply with accounting regulations by the

Financial Accounting Standards Board The Financial Accounting Standards Board (FASB) is a private standard-setting body whose primary purpose is to establish and improve Generally Accepted Accounting Principles (GAAP) within the United States in the public's interest. The Secur ...

(FASB) (for corporate defined contribution plans) or the

Governmental Accounting Standards Board The Governmental Accounting Standards Board (GASB) is the source of generally accepted accounting principles (GAAP) used by state and local governments in the United States. As with most of the entities involved in creating GAAP in the United Sta ...

(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

Stable value funds are a low risk option for retirement plans and provide stability for investors seeking to minimize volatility, which is important for an investor nearing retirement or in retirement who would want to preserve principal and minimize risk. Because of their low risk and stable, consistent returns they also can help diversify

401(k) In the United States, a 401(k) plan is an employer-sponsored, defined-contribution, personal pension (savings) account, as defined in subsection 401(k) of the U.S. Internal Revenue Code. Periodic employee contributions come directly out of their ...

asset allocation for all investors.

Comparable Investments

Money Market Funds

(also known as money market mutual fund) is an open-ended

mutual fund A mutual fund is an investment fund that pools money from many investors to purchase Security (finance), securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV in ...

that invests in short-term debt

such as US Treasury bills and

commercial paper Commercial paper, in the global financial market, is an Unsecured debt, unsecured promissory note with a fixed Maturity (finance), maturity of usually less than 270 days. In layperson terms, it is like an "IOU" but can be bought and sold becaus ...

. Money market funds are widely (though not necessarily accurately) regarded as being as safe as bank deposits yet providing a higher yield. Regulated in the US under the

Investment Company Act of 1940 The Investment Company Act of 1940 (commonly referred to as the '40 Act) is an act of Congress which regulates investment funds. It was passed as a United States Act of Congress, Public Law () on August 22, 1940, and is codified at . Along with th ...

, money market funds are important providers of liquidity to financial intermediaries. Stable value funds have outperformed money market funds in every 12-month period since 1985 with similar volatility and risk and slightly less liquidity.

Bond Funds

is a fund that invests in bonds or other debt

. Bond funds can be contrasted with stock funds and money funds. Bond funds typically pay periodic

dividend A dividend is a distribution of profits by a corporation to its shareholders, after which the stock exchange decreases the price of the stock by the dividend to remove volatility. The market has no control over the stock price on open on the ex ...

s that include interest payments on the fund's underlying securities plus periodically realized capital appreciation. Bond funds typically pay higher dividends than CDs and money market accounts. Most bond funds pay out dividends more frequently than individual bonds. Stable value funds offer returns similar to those of intermediate bond funds but with less volatility and risk, and are often recommended as a replacement for bonds in diversified portfolios.

References

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External links

Stable Value Investment Association
Investment funds