Capital preservation is a priority for many retirement investors, especially those who are in retirement or are nearing the end of their working years. Plan participants who experienced the sharp market downturn in 2008 may be particularly wary of market turbulence and may seek alternatives designed to protect their portfolios from losses. However, capital preservation cannot be guaranteed. Even if participants are attracted to a frothy stock market, advisors know that stock indexes have climbed to historic records, leaving plenty of possibilities for declines.
If plan sponsors ask about the relative “stability” of bonds as they construct fund lineups, there are known risks there, too. Bonds have had a long rally when interest rates have fallen. Most economists think rates will continue to rise as economic growth picks up, causing bond values to fall. Bonds also come in different flavors, some with more interest rate and credit risks than others. Both stable value funds and comparable-quality bond funds are generally backed by higher–quality, investment-grade bonds. But what about the impact of interest rates on comparable-quality bond and stable value funds?
Stable value funds can be an investment option for risk-averse, income-oriented participants. Although the bonds that underlie stable value funds may fluctuate in value, these funds offer capital preservation in rising-rate markets, along with income, which is usually higher than money market yields. And, as rates rise gradually, so does the income that stable value funds generate.
Right now, interest rates appear to be headed gradually up, after a nearly 30-year stretch of trending down. Plan sponsors and participants need to understand that, when interest rates increase, bond prices go down. As a result, plan sponsors and participants who are focused on preserving their assets may want to look at stable value funds as an alternative to bonds for the conservative portion of their portfolios.
Stable value funds can be constructed in many different ways, but in general they preserve capital, provide relatively attractive stable returns, and allow retirement investors to withdraw assets at book value for benefit payments. The yield from a stable value fund, or crediting rate, fluctuates with changes in interest rates and credit conditions, but the likelihood that the investor will lose money from a gradual change in interest rates and credit conditions is low.