3 Reasons Your Stable Value Fund May Not Be As Safe As You Think!

2012 October 29

Investors have historically treated stable value funds as risk-free assets, or at least close to it. Indeed, they are relatively low-risk investments and even offer a somewhat unique risk/return proposition for investors; however, stable value funds are by no means without risk. If they were, they wouldn’t pay interest in excess of the risk free rate.

A Stable Value Fund Primer

A stable value fund is essentially an insurance wrapper for a portfolio of Guaranteed Investment Contracts (GIC), which is basically a promise by an insurance company, bank, or other financial institution to pay a specified interest rate over a specified period of time. If that sounds a lot to you like a giant certificate of deposit, that’s because it is. But there’s a catch! Unlike a bank CD, this “guarantee” isn’t backed by a government agency such as the FDIC, making it only as strong as the issuing insurance company’s balance sheet. If another Hurricane Katrina hits and the insurance company goes under, your GIC investment goes down with it.

To get around this problem, a lot of 401k plans utilized so-called synthetic GIC’s instead. In a synthetic GIC, the plan invest in short-term fixed income and money market investments and then purchase an insurance wrapper from an insurance company, effectively insuring the principal against loss. Since the best stable value funds invest only in very low-risk, short-term investments and are widely diversified, these insurance wrappers end up being relatively cheap. A portfolio of 90 day treasury bills and short-term corporate paper isn’t likely to lose value so there’s not much risk to the insurance company. As we found out in 2008, though, “not much risk” and “no risk” are not the same thing, as evidenced by several large money market mutual funds breaking the buck.

But here’s all you really need to know: stable value funds are not guaranteed by any government-backed entity. They are not cash-equivalents in the same way money market funds or even certificates of deposit are. There is risk here. Not much, but it’s there.

Troubling Risks That Could Potentially Show Up

Stable value funds are great investments: I invest in one myself, but they do have a few unique risks that could come back to bite you. Investors should keep them in mind before deciding to invest.

  1. Are your stable value fund’s assets held in the general account of the issuing insurance company or a separate accounts? – If held in the general account, those assets could be exposed to lawsuits, bankruptcy, catastrophic losses, creditors, etc of the insurance company. That’s right, if the insurance company behind one of the GIC’s in your stable value fund gets sued, your investment could be at risk. I’m not sure exactly how prevalent this is, but it’s not unheard of.
  2. Stable value funds aren’t subject to the same SEC rules most investments are – Stable value funds aren’t considered registered investment products under the Investment Company Act of 1940 (view as pdf). Basically, this means there are no real disclosure rules. They don’t have to tell you what they own, who they bought it from, or even what fees you’re paying.
  3. There may be a non-disclosed (to you) surrender charge – If a surrender fee is disclosed when you make an investment and you still decide to get out for whatever reason, that’s on you. But some stable value funds have undisclosed surrender charges, meaning you aren’t told about them. Sure, they were disclosed to the plan sponsor, but there’s no guarantee the news will make it down to you, the investor. In some cases, the plan sponsor may not even understand the ins and outs of the fund enough to know about the fee themselves. If the company then opts to stop offering a stable value fund in its 401k plan, for instance, all investors will be hit by the surprise fee. Not fun.

So Should You Invest In Stable Value Funds?

Sure, if you want. Despite their problems, the best stable value funds tend to act as slightly-higher yielding short-term bond funds. The problem, of course, is that lack of disclosure makes it difficult to tell the good ones from the bad ones or even from knowing exactly how much risk you’re taking on to begin with. Is the risk large? No, probably not. The risks inherent in stable value funds are probably quite small. But the fact I can’t answer that with more precision is a definite problem, in my opinion.

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2 Responses
  1. 2012 October 30

    Kyle- I hope people heed your warning. Stable value funds carry a great deal of risk if we have an economic downturn, particularly a deflationary downturn. I have been warning my subscribers to the fact the small increase in yield is insignificant to the risk. Great job!

  2. 2012 November 4

    Good article. As an advisor to several 401(k) plans I generally use a stable value fund in most of the plans that I advise (and recommend the fund line-up for).

    The best way to think of the guarantee offered by the insurance wrapper on these funds is by visualizing the scene in the movie Its a Wonderful Life where there is essentially a run on Jimmy Stewart’s savings and loan. There is daily liquidity in these funds even when the market value/book value ratio falls to 90% or lower as many of the funds did in 2008-09. The insurance component offered by the GICS and insurance wrappers only kicks in if the fund had to sell off enough assets to fund excess redemptions that resulted in a net asset value of less than $1. To my knowledge this didn’t occur even in 2008-09. Today most stable value funds have a market/book value ratio in excess of 1oo%.

    Your concern about those stable value funds backed by the general account of an insurer is one that I have shared over the years. The final guarantee here is the state insurance pool for the appropriate state where the insurance company is domiciled. This scares me.

    I’ve not actually heard of a stable value fund imposing a surrender charge on participants. One situation that we did manage was a client changing providers. The old provider imposed a 12 month market put on the stable value fund. In plain English they wouldn’t allow the plan to move those assets to the new provider for a year. The new provider created a synthetic version of the stable value fund consisting of the assets of the old fund with new contributions going to their stable value fund. After a year any assets left in the old fund migrated over. This was transparent to the participants, there were no redemption or liquidity issues.

    The lack of transparency is disappointing. Further there is talk of future legislation that could really limit the use of stable value funds. Another problem in the present is a lack of capacity among insurers willing to participate in this market.

    None the less stable value funds can be a decent alternative to money market funds for 401(k) participants. Like anything else participants need to understand where they are putting their money.

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