Stable Value Funds: Where Investments Are Safe And Secure

Stable value funds are a type of investment fund that aims to provide capital preservation and stable returns with low risk. They are typically offered in defined-contribution plans, such as 401(k) plans, and are designed to be a conservative investment option for investors seeking steady income and low risk. The funds invest primarily in high-quality, short- to medium-term bonds, which are insured against loss of principal and yield. This insurance feature ensures that investors receive reliable interest income and protects against loss of capital. While stable value funds offer lower returns than stock funds, they provide higher yields than money market funds with relatively low volatility.

Government and corporate bonds

The funds aim to preserve capital and generate stable returns, prioritising capital preservation over high returns. They are designed to be stable, protecting investors from a decline in yield or a loss of capital. This stability is achieved through insurance contracts that wrap the underlying fixed-income strategies. These contracts are provided by insurance companies or banks, which are contractually obligated to protect investors from any loss of capital or interest.

By investing in government and corporate bonds, stable value funds can maintain a constant share price, typically set at $1. This is known as the net asset value (NAV) and is facilitated by book-value accounting, which involves recognising gains and losses over time rather than immediately.

The bonds held by stable value funds often have staggered maturity dates, providing liquidity for the fund. The funds also benefit from the high credit quality of the issuers, which further contributes to their stability and low risk.

Overall, the combination of government and corporate bonds with insurance contracts enables stable value funds to offer a stable investment option with relatively low risk and moderate returns.

Insurance contracts

Stable value funds are a type of investment fund that offers low-risk growth by investing in short-term, high-quality government and corporate bonds, alongside insurance contracts.

There are several types of insurance contracts used in stable value funds, including:

Guaranteed Investment Contracts (GICs)

GICs are stable value investment contracts issued by insurance companies that guarantee principal and accumulated interest. They typically pay a specified rate of return for a specific period, and the insurance company owns the invested assets. GICs can be backed by the issuer's general account assets or separate account assets, which are segregated from the general account for the beneficial interest of participants in a specific separate account.

Contract Value Wrap Contracts

Structurally different from GICs, contract value wrap contracts provide the same stable value benefits. The key difference is that the ownership of invested assets is held by the plan within a CIT, individually managed account, or segregated in the plan's name in an insurance separate account wrap. This split structure allows for independent decisions, such as selecting a wrap issuer, separate from choosing an investment manager. Contract value wrap contracts can be issued by banks or insurance companies.

Group Annuity General or Separate Account Contracts

Group annuity contracts are similar to GICs but lack a maturity date, and rates are reset periodically. The underlying investments and wrap provider are typically managed by the insurance company. This type of contract relies on the value of the associated assets and the financial backing of the wrap issuer to support the contract value guarantee.

Synthetic GICs

Synthetic GICs have two components: a portfolio of bonds owned by the plan or trust and managed by an asset manager, and an insurance contract that provides a book value wrap around the underlying investments.

The insurance contracts within stable value funds serve as a critical component, providing protection against losses and ensuring the stability of the fund's value.

Money market funds

Stable value funds are similar to money market funds but post higher yields with relatively little risk. They are a potential goldilocks solution. They are a type of cash fund that resembles a money market fund by offering protection of principal while paying stable rates of interest. Like their money market cousins, these funds maintain a constant share price of $1. Stable value funds have typically paid twice the interest rate of money market funds.

Guaranteed investment contracts (GICs)

A guaranteed investment contract (GIC) is a contract between an insurance company and an investor, typically a pension fund or an employer-sponsored retirement plan, such as a 401(k). The investor agrees to deposit a sum of money with the insurer for a specified period, and the insurer promises to pay the investor an agreed-upon interest rate, as well as to return the principal. GICs are sometimes referred to as funding agreements, although this term is often used for contracts sold to non-qualified institutions.

GICs are considered a low-risk investment, similar to a certificate of deposit (CD) from a bank, but they are typically purchased by institutions rather than individuals and are available in much higher denominations. They are also considered safe vehicles since most insurance companies offering them are rated in the AA to AAA range.

GICs typically appeal to investors who are risk-averse or seeking a conservative investment to balance out the more volatile portions of their portfolios. They are often offered as part of a stable value fund or a similarly named conservative investment option.

GICs usually have either a fixed interest rate or a variable interest rate that adjusts periodically based on a particular index. The guarantee of a GIC is only as solid as the insurer itself, and GICs are not federally insured like certificates of deposit (CDs). However, in 1995, the New York State Insurance Department allowed 'monoline' municipal bond insurance companies to write insurance on GICs, providing an additional layer of security.

GICs are used as a vehicle to obtain a higher return than a savings account or US Treasury securities, and they are often used as investments for stable value funds. For example, funds obtained through a municipal bond issuance can be deposited in a GIC, providing the issuer with liquidity and a higher rate of return than a money market account.

However, GICs pay a relatively low rate of interest, making them susceptible to the risk of inflation. Investors in GICs face interest rate risk, and there is a possibility of losing money in terms of purchasing power if inflation outpaces the interest earned.

Group annuities

A group annuity contract is an annuity purchased by a company on behalf of its employees. Many employers include annuities as part of a retirement benefits package to offer their employees a guaranteed stream of income once they stop working. Group annuities are designed to offer guaranteed retirement income based on the growth of an initial premium. In the case of a group annuity, the contract itself is held by an employer rather than by the individual who will receive the annuity payments.

Employers purchase group annuity contracts from insurance companies as part of the retirement benefits package they offer to employees. The premium for the contract, which is the initial amount of money used to purchase the annuity, is invested in the annuity when the employee begins receiving their retirement benefits.

Throughout the employee’s working years, the annuity is in its accumulation phase. During this time, the value of the annuity will grow at a fixed or variable rate depending on the type of annuity. Once the employee reaches retirement age, the value of the annuity contract is converted into a stream of income payments. Depending on the terms of their employer’s contract, the employee can opt to receive income payments for the rest of their life and may also be eligible to choose spousal benefits for their partner.

Variable Group Annuities

Many group annuity contracts are a type known as fixed deferred group annuities. This means that the annuity contract earns interest during its accumulation phase based on a fixed rate before converting the value of the annuity into guaranteed lifetime income payments.

Some insurance companies also offer types of annuity contracts called variable group annuities. With these annuities, the contract’s value is tied to a portfolio of investments such as mutual funds. Variable group annuities are often included in retirement plans you get from a public agency, such as 457(b) or 401(a) retirement plans.

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