A stable value fund is a portfolio of bonds that are insured, shielding investors from potential declines in yield or capital loss. Investors in a stable value fund receive consistent interest payments as agreed, unaffected by economic conditions.
Investing in fixed-income mutual funds could be the way to go if you are looking for a steady source of income without taking on too much risk. However, not all fixed-income funds are the same or offer the same kind of features and benefits. In this article, we are going to explore stable value funds, how they work and their various advantages and disadvantages.
What is a stable value fund?
A stable value fund is a type of fixed-income mutual fund that invests in high-quality government bonds and corporate bonds. One of the distinguishing features of this fund is that, in addition to investing in bonds, it also invests in an insurance plan specifically designed to protect investors from all kinds of losses, be they capital losses or interest losses. The primary objective of a stable value fund is to provide capital preservation and liquidity to its investors.
Understanding stable value funds with an example
Now that you know the meaning of a stable value fund, let us take up a hypothetical example to try and understand how it works.
An Asset Management Company (AMC) launches a new stable value fund scheme. Interested investors subscribe to this New Fund Offer (NFO). The money the investors pay is pooled together and used to invest in high-quality corporate and government bonds with strong credit ratings.
However, the AMC does not use all of the funds collected from the investors to invest in debt securities. It sets aside some funds to purchase an insurance policy on the debt securities it has invested in. The objective of the insurance policy is to protect investors from all kinds of losses arising due to the default of the debt instrument issuer.
If any of the debt instrument issuers default on the payment of either the interest component or the principal, the insurance policy will compensate the investors, ensuring that they do not suffer any losses due to such a situation.
How does a stable fund work?
Stable funds, also known as liquid funds, are a type of mutual fund that invests in low-risk, short-term debt securities to provide a stable return with minimal volatility. They invest in a mix of commercial papers, treasury bills, and certificates of deposit with a maturity period of less than one year, ensuring liquidity and minimising risk. The fund manager actively manages the portfolio to ensure diversification across different sectors and maturities, and the returns are generated through the interest earned on the debt securities. Stable funds offer a low-risk investment option with returns ranging from 4-6% per annum, making them suitable for investors seeking a stable return. They are taxed as per the income tax laws in India, and the fund manager deducts the applicable taxes before distributing the returns to the investors.
Types of stable funds
Stable value funds are a type of investment that offers a low-risk option for investors seeking a stable return. These funds are structured in various ways, including separately managed accounts, commingled funds, and guaranteed investment contracts (GICs). Here are the different types of stable value funds:
- Separately managed account
This type of stable value fund is managed for a specific 401(k) plan and provides a customised portfolio of fixed-income securities. The assets are owned by the insurance company and held in a segregated account for the benefit of the plan participants. - Commingled fund
Commingled funds pool assets from multiple 401(k) plans, offering economies of scale and diversification. These funds typically invest in synthetic GICs, which provide a guaranteed rate of return. - Guaranteed investment contract (GIC)
GICs are issued by insurance companies and provide a fixed rate of return over a set period. The invested assets are owned by the insurance company and held within the insurer's general account. - Synthetic GIC
Synthetic GICs are contracts with banks or insurance companies that guarantee a rate of return for a portfolio of assets held in an external trust. The rate of return is reset periodically and is based on the actual performance of the underlying assets. - General account contract
General account contracts are issued by insurance companies and provide principal preservation and a specified rate of return over a set period. The invested assets are owned by the insurance company and held within the insurer's general account. - Separate account contract
Separate account contracts are contracts with insurance companies that provide principal preservation and a specified rate of return over a set period on an account that holds a combination of fixed-income securities. The assets are owned by the insurance company and are set aside in a separate account solely for the benefit of the specific contract holder or retirement plan.
Advantages of stable value funds
As an investor, being aware of the various stable value funds’ benefits is crucial since it can help you make an informed investment decision. Here is a quick overview of some of the key advantages these types of mutual funds offer.
- Capital preservation
Stable value funds prioritise capital preservation over returns. It does this by investing in corporate bonds with high credit ratings and government bonds. As an additional layer of safety, these funds also invest in insurance contracts to protect investors against all kinds of losses. - Stability
Since the fund is insured, the net asset value usually stays stable throughout. The income for the investors is generated through regular interest payments from the fixed-income securities the fund invests in. Such stability in returns makes the fund a good investment option for investors seeking regular income from their investments. - Low risk
Little to no risk is another one of the most important stable value funds’ benefits. These funds enjoy significantly lower risk compared to stocks and even other high-yield bond funds. This is primarily due to the high quality of debt instruments and the insurance contracts protecting investors from losses. - Liquidity
Since the portfolio of stable value funds consists of high-quality debt instruments with stellar credit ratings, the demand for such mutual fund schemes is often high. Such high demand makes it easy to purchase and sell units of the funds quickly, making them highly liquid investment options.
Disadvantages of stable value funds
Merely knowing the stable value funds’ benefits is not enough. As a prospective investor, you must also make yourself aware of the various risks involved with these funds. Let us walk through some of the key disadvantages of these funds.
- Low returns
Since stable value funds are low-risk and invest in high-quality debt instruments, the interest rates are often very low. This leads to lower returns on investments. - High costs
The expense ratios of stable value funds tend to be on the higher side compared to other debt mutual fund schemes, primarily due to the added insurance component. The added cost of insurance premiums could potentially reduce the already low returns that investors get from investing in these funds.
Conclusion
Stable value funds could be a good investment option for investors with a low tolerance for risk and who prioritise capital preservation and liquidity over returns. However, it is essential to recognise that these funds are meant to offer stability, not high returns. Furthermore, the concept of stable value funds is currently only prevalent in international markets such as the U.S.
In markets like India, for instance, stable value funds have not yet become popular. However, if you still wish to enjoy similar benefits such as capital protection, low risk and high liquidity, you could consider investing either in capital protection funds or Gilt funds. You can find such funds and more on the Bajaj Finserv Mutual Fund Platform. Additionally, you can also compare mutual funds with one another across different aspects to determine which one is right for you before investing.
Calculate your expected investment returns with the help of our investment calculators
Investment Calculator |
||