What is a Stable Value Fund?

For investors looking to invest systematically, they diversify across various sectors such as fixed-income products, which include a lower risk than other investment avenues. When these investors know that they will receive a predetermined amount as interest at regular intervals, they increase their overall risk appetite to earn higher profits.

Although investors choose fixed-income instruments for their feature of regular payments, these fixed-income instruments have their risks. When the risk factor negatively affects the interest payments of fixed-income instruments, investors lose money. Additionally, if their investments in other asset classes (where they took higher risks based on the low risk of fixed-income instruments) goes through a bear phase, the overall portfolio tanks.

What should you do then? Stop investing in fixed-income instruments? The answer is no, as fixed-income instruments are critical in the overall success of the portfolio. However, you can invest in fixed-income instruments through a Stable value funds. The fund ensures that you get the same amount as an interest payment while your principal amount remains the same.

What is a Stable Value Fund?

A stable value fund is a low-risk investment that invests and creates a portfolio of fixed-income instruments and wraps it with insurance from an insurance company or a guarantee from a bank. The insurance and guarantee includes the fixed-income instrument to ensure the preservation of the capital or principal amount. With a stable value fund, the investors retain the original value of the invested cash, irrespective of external affecting factors such as the performance of the stock or the bond market. The process of a stable value funds makes the overall investments low-risk. However, the subsequent returns are low as well.

How do Stable Value Funds work?

Stable value funds work on the principle that the investor should not suffer because of the market conditions, and the fixed-income instrument they have invested in should continue to offer the original interest rate throughout their tenure. They ensure this by backing the investments in fixed-income instruments with an insurance policy or a bank guarantee. This backing by an insurance company or a bank is known as Wrap Contracts which offer a certain guaranteed return, even if the underlying asset attached with the instrument declines in value. The insurance company or the bank relies on the financial backing and the value of the associated assets to support the guarantee they provide for a stable value fund.

When you invest in a stable value fund, it means that your principal amount will never be lower than the initial investment at any point. If due to any external factor, the fixed-income instrument does lose its value, the wrap contract issuer is legally bound to match the lost value and make the funds whole. With a stable value fund, the initial investments become stable throughout, and the investors continue to receive the same returns as guaranteed by the instrument at the time of investment.

Pros and Cons of Stable Value Fund

Now that you have understood the stable value fund definition, you would think that there is no possibility of loss after investing through a stable value fund. However, as it is with every market linked instrument, stable value funds also come with their advantages and disadvantages. Here are the pros and cons of investing in fixed-income instruments through a stable value fund.

Pros:

• Low-Risk: Stable value funds decrease the overall risk to a negligible level. It is because they ensure that the investment amount continues to be stable without going below the initial principal amount.
• Wrap Contracts: Stable value funds are backed by wrap contracts that insurance companies or banks issue. Due to these wrap contracts, the investment is protected against any negative external factor. Furthermore, it also allows the investors to receive the lost value from the insurance company or the bank to make the funds whole.
• External Factors: As stable value funds are backed by wrap contracts from insurance companies or banks, they ensure that the investment is not affected by negative market factors. In times of stock market volatility or recession, stable value funds ensure guaranteed returns.

Cons:

• Complicated structure: Fixed-income instruments are complicated to understand in detail as many external and uncertain factors can influence their returns. However, when they invest through stable value funds, the complex nature of the overall process intensifies, confusing investors in understanding their investments.
• Bankruptcy: It is said that stable value funds are as good as the insurance company or the bank that backs them through the wrap contracts. In case the insurance company or the bank becomes bankrupt and shuts operations, it may seize an investor’s power of legally demanding the backing of the investments done.
• Higher Costs: Because of the insurance and the bank guarantee, stable value funds come with higher management costs. This lowers the overall risks earned by stable value funds, which are already lower when compared to other investment instruments.

Types of Stable Value Funds

As there are numerous fixed-income instruments, the respective stable value funds can also take various forms. Some of the widely used stable value funds are listed below for better understanding:

• Separately Managed Account: This type of stable value fund is generally offered by an insurance company where it keeps assets in a segregated account. Using these assets, the insurance company backs the investments. The insurance company owns the assets held in the segregated account for the benefit of the investment participants.
• Commingled Fund: This type of stable value fund combine assets from a variety of other plans, such as unaffiliated retirement funds or provident funds, allowing smaller investments to gain economies of scale.
• Guaranteed Investment Contract (GIC): Issued by an insurance company, these types of stable value funds pay a certain rate of return as interest over a stretched period. The insurance company may back the investments through its general account assets, or it can utilise the process of separately managed accounts to back the investments through assets held in a segregated account. The insurance company’s obligation to the investors is backed by the full credit of the company and its financial strength.
• Synthetic GIC: This type of stable value fund is similar in nature and operations to the Guaranteed Investment Contract. However, the assets are kept in the name of the trustee of the investment plan or the retirement plan itself.

Conclusion

Fixed-income instruments are an effective way to ensure diversification and a regular stream of income. Furthermore, they result in increasing the risk appetite of the investor, who can then invest in high-risk instruments to increase the overall profits of the portfolio. However, as high-risk investments are immensely volatile and are affected by external factors, fixed-income instruments are valuable to protect the portfolio's overall value.

When looking at a stable value fund, you should check the costs attached with the fund as it can lower your yield and decrease the profits you make through the stable value fund. You can visit IIFL’s website for any other queries regarding how you can use stable value funds to improve your profits and decrease your risk profile.