1 Stable value funds have a low sensitivity to interest-rate changes
Stable value, capital preservation, and bond funds invest in fixed-income securities. The prices and yields of these securities have an inverse relationship. What does this mean? When interest rates rise, the market value of a bond portfolio typically decreases. The opposite is true when interest rates decline, but not every bond or capital preservation fund responds the same way. Some rise or fall more than others. What determines their response? The investment’s duration profile. The shorter the duration, the smaller the reaction when interest rates change.
Pooled or commingled stable value funds generally have a duration of two to four years. General account stable value funds have a target duration of four to seven years. As such, stable value funds tend to react less in a rising interest-rate environment than investments with longer duration profiles and are positioned to handle volatile market conditions.
2 Stable value’s crediting rate formula helps reduce investment volatility
The crediting rate formula (interest calculation) for pooled stable value funds helps provide consistent performance across economic cycles. How? The formula permits the amortization of portfolio gains and losses over the duration of the stable value fund, which helps smooth out returns for participants. Traditional bond portfolios don’t have this ability; they’re generally marked to market daily. That’s why traditional bond portfolios will typically experience more pronounced fluctuations in their performance during periods of inflation and rising interest rates compared to stable value funds.
3 Increased cash flows can lead to higher crediting rates
Many retirement plan participants, and investors in general, tend to shift their money from equity funds to safer investments, such as stable value and money market funds, during periods of inflation and rising interest rates. Stable value fund managers can use this influx of cash to purchase higher-yielding fixed-income securities. As a result of these purchases, the crediting rate (interest rate) of your stable value fund may increase.
How quickly will the crediting rate change? It depends on the fund’s reset frequency. If the stable value fund resets monthly, its crediting rate will likely increase one month after the higher-yielding bonds are purchased. If the fund resets quarterly or semiannually, participants in a retirement plan may need to wait three to six months to see their crediting rate go up.
Follow and trust your process
Part of acting in the best interest of participants means reviewing investment lineups whenever circumstances change to see if action is required. Any decision to remove or replace a stable value fund requires careful thought and deliberation. Discussion should focus not only on the economic environment, but also the fund’s long-term performance, the role it plays in the plan, and how it compares with alternative investments in the same and similar asset categories. By following a documented process, plan sponsors can look at the big picture and choose the best course of action.
For complete information about a particular investment option, please refer to the fund sheet and prospectus or offering memorandum/trust document. Investors should carefully consider the objectives, risks, charges, and expenses before investing. The prospectus or offering memorandum/trust document contains important information about the investment option and investment company. These documents may only be available in English.
Stable value portfolios typically invest in a diversified portfolio of bonds and enter into wrapper agreements with financial companies to prevent fluctuations in their share prices. Although a portfolio will seek to maintain a stable value, there is a risk that it will not be able to do so, and participants may lose their investment if both the Fund's investment portfolio and the wrapper provider fail.
The views presented are for informational purposes only as of the posting date and are subject to change based on the market and other conditions, as well as on information about a fund’s holdings, assets allocation, or country. There is no guarantee that any investment strategy will achieve its objectives. Past performance does not guarantee future results.
All overviews and commentary are intended to be general in nature. While helpful, these views are no substitute for professional tax, financial, or legal advice. Clients should seek professional advice for their particular situation. Neither John Hancock nor any of their affiliates or representatives are providing tax, financial, or legal advice.