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- Updated 04 Dec 2023
Key Highlights
- A stable value fund is an investment that invests in fixed-income instruments backed by bank or insurance guarantees.
- Low risk, wrap contracts that protect against losses, and stability during market volatility are some of the benefits of stable value funds.
- Complex structures, potential bankruptcies of backing institutions, and high costs of management are among the cons.
Understanding Stable Fund
Stable value funds are low-risk investments (like money market funds) with higher yields (like bond funds). The fund does this by holding a short-term bond fund as well as an added insurance feature that protects investors from losing principal. Although high-quality bond funds are low-risk investments with much lower volatility than stocks, there is no guarantee that their value will not decrease when interest rates rise.
Long-term average quarterly returns on stable value funds have historically been higher than money market fund returns. Furthermore, stable value fund returns have been comparable to intermediate-term government bond returns.
How Does a Stable Fund Work?
The idea behind stable value funds is that investors shouldn't suffer from market fluctuations, and the fixed-income instrument they have invested in should continue to yield the original interest rate. They do this by backing their investments in fixed-income instruments with insurance policies or bank guarantees. The backing by a bank or insurance company is known as wrap contracts, which guarantee a certain return regardless of whether the underlying asset goes down in value. Insurers or banks provide a stable value fund with a guarantee based on financial backing and assets.
Stable value funds guarantee that your principal amount will never drop below the initial investment. If an external factor causes a fixed-income instrument to lose its value, the wrap contract issuer is legally required to restore the lost value. Investors in stable value funds continue to receive the same returns as promised by the instrument at the time of investment.
Types of Stable Funds
Listed below are some of the most widely used stable value funds:
1. Separately Managed Account
Insurance companies generally offer this type of fund, where assets are held in a segregated account. The insurance company backs investments with these assets. For the benefit of investment participants, the insurance company owns the assets in the segregated account.
2. Commingled Fund
Stable value funds combine assets from other plans, including unaffiliated retirement funds and provident funds, allowing smaller investments to benefit from economies of scale.
3. Guaranteed Investment Contract (GIC)
These funds are issued by insurance companies and pay interest over a long period. Investments may be backed by the insurance company's general account assets, or they may be backed by assets held in a segregated account through the process of separately managed accounts.
4. Synthetic GIC
In terms of nature and operation, this type of stable-value fund is similar to the Guaranteed Investment Contract. The assets of the investment plan or retirement plan are kept in the name of the trustee.
Pros and Cons of Stable Funds
Having learned about stable value funds, you may believe there is no possibility of losing money by investing in one. However, like any market linked product, stable value funds also have pros and cons.
Low-Risk: There is little risk associated with stable-value funds. They keep the investment amount stable without going below the initial principal. | Complicated structure: There are a variety of external and uncertain factors that can influence fixed-income returns, which makes them difficult to fully understand in detail. However, when investors invest through stable value funds, the complex nature of the overall process intensifies, making investing more difficult. |
Wrap Contracts: Stable value funds are backed by wrap contracts issued by insurers or banks. These wrap contracts protect the investment from external factors that may negatively affect it. Additionally, the investor can receive the lost value from the insurance company or bank to make up for their losses. | Bankruptcy: In the wrap agreements, stable value funds are backed by insurance companies and banks. However, if an insurance company or bank goes bankrupt, it may seize an investor's right to legally demand the backing of their investments. |
External Factors: Due to the backing of wrap contracts from insurance companies or banks, stable value funds ensure that negative market factors will not affect the investment. Funds with stable value provide guaranteed returns during market volatility or recession. | Higher Costs: Stable value funds have higher management costs due to the insurance and bank guarantee. |
Conclusion
Stable funds invest in high-quality government and corporate bonds, short- and intermediate-term. Investing in them is similar to investing in any bond fund, except that they are insured. A bank or insurance company is contractually obligated to protect fund investors against capital losses. You can go through various value fund examples to better understand the concept. However, check the costs associated with a stable value fund before investing, as they may lower your yield and decrease your profits.
