Understanding Stable Value Interest Rates
One of the reasons that the Stable Value Option can achieve attractive returns compared to short-term money market rates is because the underlying investments have longer maturities. In general, longer maturity bonds typically have higher interest rates than shorter maturity investments.
The Stable Value Option has two important components, a portfolio of short and intermediate-term bonds, and specific types of contracts called ‘wrap contracts’ which are issued by a bank or an insurance company. The purpose of the wrap contracts is to smooth the impact of fluctuating interest rates and their effect on bond prices. This allows investors to earn bond-like returns with similar volatility to that of money market funds. One of the primary objectives of the Stable Value Option is to provide relatively consistent returns during periods of both rising and falling interest rates.
When interest rates rise, the market value of a bond can decrease. Therefore, it’s common that the bond is held until maturity. If the bond had been immediately sold to purchase a higher-paying bond, it would have been sold at a loss. If the bond is instead held until maturity, the full face value of the bond is received. This money can then be used to purchase a new bond, which may have a higher interest rate. Some bonds in the Stable Value Option are very near their maturity dates, while others are years away. Since only the maturing bonds are typically reinvested, it takes longer for the higher interest rates to be reflected in the Stable Value Option’s yield. Thus, the increase comes gradually, rather than immediately.
We are currently in an environment in which interest rates have been rising. In this type of environment, the Stable Value Option’s yield may lag behind the increases in short-term investments, gradually catching up as the bonds are reinvested at higher interest rates available in the market. Conversely, when interest rates declined in previous years, the same “lag effect” provided more favorable stable value returns compared to short-term interest rates. Regardless of the current interest rate environment, it is important to recognize that investments like the Stable Value Option normally outperform short-term investments over the long run. This favorable long-term performance record and the slow movements in the rate of return are why the Stable Value Option has been so popular.
If you have additional questions about the Stable Value Option, please feel free to contact the Service Center at 877-644-6457.