Money Market Funds or Stable Value Funds: Which Are Right for Your Clients?

Capital preservation investments can be challenging to understand. Both money market funds and stable value funds are designed to offer low risk and protect the principal. But these two options vary significantly in terms of returns, volatility and suitability for different market conditions.

Help clients understand by helping them explore the differences.

Money Market Funds

Money market funds are mutual funds that invest in short-term, high-quality debt securities. These include Treasury bills, certificates of deposit and commercial paper. They offer high liquidity with a low level of risk.

The primary benefits of money market funds include:

• Liquidity: Investors can easily access their funds at any time without a penalty.
• Stability: Money market funds aim to maintain a stable net asset value, or NAV, of $1 per share.
• Safety: Investments are typically in high-quality, short-term securities, which can minimize credit risk.

The returns on money market funds, however, are generally lower compared to other investment options. During periods of low interest rates, the yields can be minimal, barely outpacing inflation.

Stable Value Funds

Stable value funds are designed to provide higher returns while still preserving capital. These funds invest in a diversified portfolio of bonds and other fixed-income securities, often attached to or contained within insurance contracts.

Key features of stable value funds include:

• Capital preservation: Like money market funds, stable value funds aim to preserve the principal and provide steady growth over time.
• Market competitive returns: Stable value funds typically offer market competitive returns, which historically have been higher returns compared to money market funds. This is due to their investment in longer-term securities and the use of insurance contracts to stabilize returns.
• Low volatility: The insurance contract guarantees a specific rate of return over a set period, regardless of changes in interest rates. This means that if interest rates rise or fall, the stable value fund's return remains steady, providing a predictable return for investors.
• Guaranteed rate: Some stable value funds may also offer a guaranteed rate of return, or crediting rate. Investors are assured a specific return on their investment over a set period, regardless of market conditions.

Consider these other factors when comparing money market funds and stable value funds.

How are the funds affected by interest rates?

Changing interest rates have a direct effect on capital preservation products. The effect will differ based on the investment strategy of the product.

Money market funds invest in short-duration investments like Treasury bills, so changes in interest rates are felt more immediately. The effect can be positive or negative, depending on the direction of rates. Short-term investments generally provide a lower return than alternatives with longer-duration investment strategies. Generally, the longer the maturity, the higher the return.

Stable value funds, in contrast, typically invest in longer-maturity, fixed-income products like intermediate-term bonds and commercial mortgages. These investments generally provide higher returns compared with short-term investments. As interest rates for these types of investments fluctuate, and new investments are purchased at the prevailing rates, the crediting rate of the stable value fund will adjust accordingly, based on its rate schedule. However, the changes in interest rates will be felt more gradually compared with money markets because the investments have a longer duration.

What risk factors should be considered?

Money market funds and stable value funds each come with their own set of risk factors.

While both money market and stable value funds are generally safe, both are subject to interest rate risk, where rising interest rates can lead to a decline in the value of the fund’s portfolio due to securities being purchased at lower interest rates. Additionally, there is credit risk, as the issuers of the debt securities may default on their obligations. Liquidity risk can also arise if the fund's liquidity falls below required minimums due to market conditions.

Since stable funds are designed to provide higher returns, the insurance contracts it is attached to or held within may introduce counterparty risk if the insurer fails to meet its obligations. Stable value funds may face market value adjustment risk, where, upon discontinuance, the value of the fund's assets may be adjusted based on market conditions.

Are there differences in regulatory oversight?

Both money market funds and stable value funds are subject to regulatory oversight, but by different entities.

Money market funds are regulated by the Securities and Exchange Commission, or SEC, under the Investment Company Act of 1940. The SEC’s rules enhance the stability and liquidity of money market funds. This includes requirements for maintaining a stable NAV, liquidity fees and redemption gates. Money market funds must also adhere to strict credit quality and maturity standards to minimize risk.

Because stable value funds are typically attached to or contained within insurance contracts, they’re regulated by state insurance departments. The insurance contracts may provide a guarantee of principal and interest. State insurance regulations include requirements for reserve levels, credit quality and disclosure. Stable value funds offered within certain retirement plans must adhere to The Employee Retirement Income Security Act of 1974, or ERISA guidelines, ensuring fiduciary responsibility and participant protection.

The choice between money market funds and stable value funds depends on the client's unique needs. For employers who want to help risk-averse employees experience steady growth and preserve their investment, stable value funds could be an appropriate solution. Help your clients get to know more about stable value funds with our Stable Value 101 guide.

Contact a stable value consultant to learn more.