2022 was an unprecedented year for fixed income markets, as the U.S. Federal Reserve pivoted away from accommodative policy and embarked on a hawkish rate-hike path, signaling a strong commitment to rein in inflation. The federal funds rate range ended the year at 4.25%–4.50% after beginning the year at 0%–0.25%, which highlights 2022’s market volatility.
The yield curve inverted, with short-term rates rising higher than long-term rates. Not surprisingly, the Fed’s actions benefited money market funds, whose yields respond quickly to changes in short-term interest rates. For context, the average 7-day yield of government money market funds (based on Crane Data) was 0.01% on December 31, 2021, and ended 2022 at 3.70%.
Capital preservation: Money market or stable value?
Government money market funds and stable value funds are the two primary capital preservation options for DC plans. In 2022, stable value pooled fund crediting rates moved higher as well, but by a smaller amount than money market yields. This was due to the “lag effect,” as lower market-to-book ratios offset higher yields within portfolios. As a result, government money market fund yields are now higher than stable value fund crediting rates.
While we acknowledge the reality of the current market environment, we believe this yield advantage of government money market funds compared with stable value funds is a short-term phenomenon and must be discounted as such.
Over longer periods, stable value maintains its advantage
Importantly, we believe investors should focus on evaluating longer-term returns for both products, given retirement investing is a long-term endeavor. In this context, stable value funds continue to provide a significant annual return premium over money market funds.
The chart below compares the 5-year rolling returns for stable value funds and the ICE BofA 3-Month Treasury Bill Index (a proxy for government money market returns) over the past 30+ years.
Stable value funds are shown to have an average annual return premium above 3-month Treasury bills of approximately 175 basis points. Importantly, this return advantage includes multiple time periods when the yield curve was inverted, as it is today, including the late 1980s, early 2000s, and the period leading up to the global financial crisis.
Stable value has a long-term performance advantage over money market funds
Comparison of 5-year rolling returns
Sources: Federal Funds Effective Rate as retrieved from FRED, Federal Reserve Bank of St. Louis; T-bill returns as represented by the ICE BofA (Intercontinental Exchange Bank of America) U.S. 3-Month Treasury Bill Index, an unmanaged index that seeks to measure the performance of U.S. Treasury bills available in the marketplace; and Stable Value returns as represented by the Morningstar US CIT Stable Value Index, which measures the performance of approximately 75% of the U.S. collective investment trust stable-value fund pooled universe.
Please visit our How we invest: Stable Value: Advantages page for a printable version of the chart above.
Stable value volatility is lower than that of money market funds
Furthermore, the volatility profile of stable value funds has been lower than that of money market funds and much lower than that of intermediate-term bonds over this same time period.
The following chart highlights the volatility of monthly returns over the past 30 years. The stable value category, as indicated by the green line, clearly shows the stability of the return experience that participants enjoy from investing in stable value funds over the long term.
The smoothness of the return profile is directly attributable to the crediting rate formula. The formula is designed to dampen the quarterly market value return volatility experienced while providing a superior return stream for stable value investors over time.
Stable value funds perform with lower volatility than money market funds
Comparison of monthly return volatility, 1990–2022.
Sources: Bloomberg Intermediate Government/Credit Index, Morningstar U.S. CIT Stable Value Index, and iMoneyNet MFR Money Funds Index.
Key structural differences between stable value and government money market funds
Stable value funds pursue capital preservation by investing in a mix of intermediate- and short-maturity fixed income securities and contracts that are issued by insurance companies or banks. This is a key advantage, as the insurance contracts allow participant balances to be held at book value, insulating participants from day-to-day fluctuations in bond prices.
Additionally, stable value funds can invest across the spectrum of investment-grade fixed income sectors. In contrast, government money market funds must invest 99.5% in government/agency securities with short maturities. These underlying differences in investments lead to portfolios that look very different by many metrics.
Government money market funds have a maximum weighted average maturity of 60 days, while stable value funds have average maturities typically between two and four years. Despite these differences, stable value funds still offer the same level of principal protection as money market funds while historically providing a higher return over the long term.
Putnam offers resources
Putnam is experienced as a stable value manager and offers educational resources that can be part of your efforts to learn more. Please visit How we invest: Stable Value to discover materials that explore our liquidity-first approach and the value we find investing in GICs.