Stable Value Funds Expected to Prevail Despite Short-Term Interest Rates
Since stable value funds invest in intermediate-term bonds and money market funds invest in short-term bonds, the recent rise in short-term interest rates has been creating some challenges for stable value funds, but experts say that condition is cyclical and that these funds should still hold great appeal for retirement plan sponsors and participants.
“Obviously, the interest rate environment over the past 12 months has been very challenging for stable value funds,” says Jonathan Kreider, vice president of investment products at Great-West Financial in Greenwood Village, Colorado. “There have been two headwinds. The increase in rates in the belly of the yield curve and the flattening of the curve is one, which is cyclical. The other challenge is structural. We are at a 10-year anniversary of the bull market in equities. All bull markets come to an end, and the cycle will dissipate.”
John Faustino, chief product and strategy officer at Fi360 in Chicago agrees that while the increase in short-term interest rates can make stable value funds a little bit less attractive than money market funds, this is usually a short-lived phenomenon. “It is true that rising short-term interest rates could create yields in money market funds that exceed those of stable value funds,” Faustino notes. “Over the past 50 to 60 years, there have been 10 times when the yield curve inverted, whereby three-month Treasury yields, more similar to money market durations, have been higher than five-year Treasuries, more similar to stable value duration.” However, what is important to note, he says, is that when those inversions did occur, they only persisted for five to six months.
“Since many stable value funds have provisions that require a plan sponsor to give 12 months’ notice before moving to a competitive product, it likely won’t make any sense for a plan sponsor to move,” Faustino says.
Kreider says it is also important to note that “if a change in interest rates occurs slowly over time, stable value funds’ crediting rates will be more responsive. There will be fewer losses in the underlying bonds, so the crediting rate is unlikely to decline. If the interest rate move is rapid, however, crediting rates might actually drop in the face of higher interest rates.”
Additionally, it is important to be aware of the fact that while stable value fund returns may for a time fall below those of products invested in short-term bonds, “there is always a lag for stable value funds to follow those returns,” but they always do.
Gary Ward, head of stable value at Prudential Retirement in Newark, New Jersey, says the recent market volatility should be a reminder to plan sponsors and participants of the critical role that stable value funds offer them. Since stable value funds offer steady returns with guaranteed principle, participants may want to include them in their portfolio, he says.
Additionally, with interest rates now rising, it is important to be aware that “stable value products are built to be responsive to rate increases without volatility in the returns,” Ward continues. “Stable value products are built for different market cycles and interest rate conditions, offer long-term benefits and are ideal for long-term savings vehicles like defined contribution plans.”
When considering a stable value fund, plan sponsors and advisers should conduct a thorough due diligence, Kreider says. This includes looking at “the credit rating of the issuer, the composition of the investment portfolio, the capital and reserves available to support guarantees, the historical crediting rates of the portfolio, termination provisions and any potential recordkeeping price reductions associated with the use of the product. Many clients will use a stable value fund that is offered by an investment manager affiliated with the recordkeeper. In these instances, we often see recordkeepers lower the overall, bundled price.”
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