It’s been awhile since stable value funds reigned as a top investment choice for 401(k) plan participants. Very low prevailing interest rates and a booming stock market have diminished their status. Although no one is predicting they’ll unseat target date funds as the top investment election for retirement investors, stable value funds have staged a bit of a comeback recently.
Types of funds
According to the Department of Labor, a stable value fund is an “investment product or fund designed to guarantee principal and a rate of return generally consistent with that earned on intermediate investment grade bonds, while providing liquidity for withdrawals by participants and beneficiaries, including transfers to other investment alternatives.”
Stable value funds consist of portfolios of short- and intermediate-term bonds, but with an insurance contract overlay, or “wrapper,” and come in two types:
- Direct contract. These are issued by a single insurance company that guarantees the fund’s principal and yield over a specified time period. The guarantee of the minimum promised yield and return of principal is backed by the insurance company’s general assets.
- Collective investment trust. These trusts consist of multiple underlying insurance contracts. The compensation for a collective investment trust’s lower yield is a higher level of security derived from that diversification. However, direct contract stable value funds generally have higher (perhaps by 30 basis points) yields than collective investment trusts.
The strong insurance backing of stable value funds doesn’t get plan sponsors off the fiduciary hook when selecting a stable value fund provider, of course. The same due diligence is required as when selecting any other plan investment. Some insurance companies are stronger than others, and some state guaranty associations are also more solid than others.
An uptick in assets
Specifically, stable value funds have risen from 10.4% of plan assets in 2014 to 12% in 2017, according to the Stable Value Investment Association (SVIA). That proportion hit 19% during the 2008 financial crisis, when average fund yields hovered around 5%.
The SVIA sees two reasons for this uptick. First, in 2016, the SEC issued regulations requiring money market funds sold to “retail” investors to invest exclusively in government securities. These funds yielded very low interest rates. About 13% of plan sponsors who made changes to their fund offerings in response to that regulatory change added a stable value fund to their plans, according to Callan Associates research.
And, some plan sponsors regard stable value funds as a higher yield alternative to money market funds. Current average stable value fund yields are hovering in the 2.5% range, according to the SVIA, vs. around 100 basis points for money market funds.
Second, stable value funds could provide for a smoother ride than higher-yielding bond funds for retirement savers in a rising interest rate environment — a long-predicted economic scenario that has yet to occur in any significant way. The smoother ride would stem from the fact that yields on stable value funds are by definition stable — with guaranteed minimum yields and “crediting rates” (interest actually paid) generally level for six-month periods — even if the market values of their underlying short- and intermediate-term bonds aren’t.
In a rising interest rate environment, declining bond fund values could raise anxiety levels among retirement savers, and result in actual losses for retirees if forced by financial necessity to liquidate some of their depressed bond fund holdings in retirement.
Time to decide
Your ultimate analysis will involve the suitability of a stable value fund for your employee population. While a stable value fund might provide a reasonable alternative to bond funds for particularly risk-averse plan participants, few would be well served by seeking the shelter of a stable value fund as an alternative to a well-diversified portfolio. Contact your benefits specialist to learn whether these funds are right for your plan.
BPM is one of the largest California-based public accounting and advisory firms, ranked as one of the 50 major firms in the country. With six offices across the Bay Area – as well as offices in Hong Kong and the Cayman Islands – we serve emerging, mid-cap, and closely-held businesses as well as high-net-worth individuals in a broad reach of industries. Our Employee Benefits team consists of professionals with extensive knowledge of ERISA guidelines and deep expertise performing employee benefit plan audits. We can help you craft a smooth-running plan that serves your employees while mitigating associated risk. For more information or for a free expert consultation, contact Jenise Gaskin at (925) 296-1016, Michelle Ausburn at (707) 524-6588 or visit us at bpmcpa.com/ebp.
Stable Value Funds As Temporary QDIAs
Stable value funds can serve as a temporary qualified default investment alternative (QDIA). Under Department of Labor regulations, four types of investment options qualify as QDIAs:
- A product with a mix of investments that takes into account the individual’s age or retirement date (such as an age-based life cycle or target date fund),
- A product with a mix of investments that takes into account the characteristics of the group of employees as a whole, rather than each individual (such as a balanced fund or risk-based lifestyle fund),
- An investment service that allocates contributions among existing plan options to provide an asset mix that takes into account the individual’s age or retirement date (such as a professionally managed account), and
- A capital preservation product (such as a stable value fund) for only the first 120 days of participation (an option for plan sponsors wishing to simplify administration if workers opt out of participation before incurring an additional tax).
If plan sponsors choose to use a stable value fund as a temporary QDIA, they must transfer the participants’ accounts to one of the first three QDIA options listed above by the end of the 120-day period.