Fixed income investing is supposed to be the stable portfolio anchor. After all, the segment’s steady coupon payments coupled with the fact of principal return is designed to cushion a portfolio. However, last year was anything but steady. With the worst return for bonds in roughly 250 years, fixed income investors were reminded that volatility still exists.
But it doesn’t have to be that way. A staple of many retirement plans could be a fixed income investor’s best friend in the current environment and beyond.
Stable value funds offer a quasi-bond/cash hybrid that beats the return on cash while still providing plenty of inflation protection. And now with rates rising, stable value funds offer an alternative to bonds.
Don’t forget to check our Fixed Income Channel to learn more about generating income in the current market conditions.
Rising Rates & Guarantees
We all know that rates have begun to rise, which has put many bond investors on high alert. Thanks to the inverse relationship between bonds and interest rates, prices for bonds have dipped considerably over the last year. As the Fed raised rates from 0 to 4.25%, the broad Bloomberg US Aggregate Bond Index lost nearly 13% last year – the worst return for bonds in over 250 years. And with rates predicted to rise even further this year, bond market volatility is here to stay.
Which is why the humble stable value fund (SVF) could be a fixed income investor’s best friend going forward.
Also called Guaranteed Investment Contracts, Capital Preservation Funds or Principal Protection Funds, stable value funds are only found in defined contribution plans like 401(k)s or 403(b)s. Most of us have access to them with an industry group like the Stable Value Investment Association, showing that 3 out of 4 defined contribution plans have an SVF as an investment option.
Basically, a stable value fund is a portfolio of bonds with an insurance wrapper around them. A stable value fund will own a portfolio of short- and immediate-term bonds that can be actively managed or index-based. Around that portfolio of bonds is an insurance policy which prevents losses. So, when the price of the bonds dip, the insurance kicks in and investors don’t notice the losses and the share price of the SVF doesn’t move an inch. SVFs allow investors to ignore the gyrations of the fixed income market due to rate increases and economic worries.
Now, remember that there are some trade-offs when using a stable value fund. Insurance isn’t free and in exchange for that protection and stability, investors give up some yield. As a result, a stable value fund will yield about 1 to 2 basis points lower than an intermediate bond fund. However, investors will pay about 1 to 2 basis points more than a money market fund.
Benefits of SVFs
It turns out that the loss of yield isn’t a big deal when looking at total returns. In fact, stable value funds have outperformed money market funds, short- and intermediate-term bond funds over the long haul. For the 10- and 15-year periods ending in September 2022, stable value funds managed to produce average annual returns of 2.5% and 3.08%, respectively. This compares to average annual returns of 0.99% and 2.5% for intermediate bonds in the same periods.
So, SVFs statistically beat bonds. But what about cash? Does the insurance wrapper help produce stability while still beating on yield? The answer is a resounding yes. Because the share price doesn’t dip, a stable value fund has the same capital preservation attributes as a money market fund. But the extra yield makes it a better option. If you invested $1 in a money market fund back in 1988 and held onto it, the fund would be worth $2.35 today; that same dollar in a SVF would be worth $5.42.
With that, investors get bond beating returns with the stability of cash.
Adding a Stable Value Fund to Your Portfolio
Given the benefits of a stable value fund – stability and strong returns – investors may want to consider one for their portfolios. And now could be a great time. Yields on stable value funds continue to rise as the Fed has raised benchmark rates. This makes SVUs a good option for investors seeking stability and yield from their portfolios. These funds are particularly advantageous to investors near or in retirement.
Buying an SVU is easy. The vast bulk of retirement plans offer it as an option, and adding it to your portfolio is as easy as selecting it in your 401(k).
Now, there are some caveats. If you roll over a 401(k) plan, you will most likely lose your ability to invest in the SVF. So, it may make sense to leave a portion of your funds in a 401(k) when you retire to still have access. Secondly, some stable value funds do have some gatekeeping requirements, such as a 30- or 90-day restriction on new investment withdrawals. These caveats prevent short-term trading in and out of the funds. With that, it’s best to think of them as long-term capital preservation/growth elements.
All in all, stable value funds offer a unique and often ignored tool for investors. With bond-beating returns and cash-like stability, SVFs make for an ideal holding for fixed income investors near or in retirement.
Take a look at our recently launched Model Portfolios to see how you can rebalance your portfolio.
