Stable Value Is Better Than Bonds

Tony Ash profile picture
Tony Ash


  • The consensus view continues to favor higher rates and puny or negative bond returns over the medium term.
  • 401-k asset allocation decisions based on these capital market forecasts force risk-averse investors into bonds only to reduce risk, while offering little return.
  • Current market pricing makes it better to use Stable Value Fund options (Guaranteed Investment Contracts) in your 401-k plan to get the positive returns without downside risk.

Consensus forecasts continue to favor higher rates and low bond returns over the medium term. GMO, the Boston-based global investment firm, recently updated its 7-year real return forecast and projected a dire situation for most asset classes, including a projected -2.1% real return for U.S. bonds. Most investors understand the risk/return tradeoff expressed by stocks, but are not expecting a projected negative return coming from the less risky bond asset class represented by the iShares Core Total U.S. Bond Market ETF (NYSEARCA:AGG).

Capital market forecasts like these confound the asset allocation decision for risk-averse investors. Though these forecasts are always accompanied by significant disclaimers, it is not difficult to envision a scenario where the enormous post-crisis easing by central banks around the world finally takes hold and inflationary pressures force rates higher and bond prices lower. This could have severe consequences for bond investors near or in retirement.

Vanguard recently published its 15th annual study of its record keeper business covering $800 billion across 1.4 million participants in 401-k plans, How America Saves 2016. It shows that the fixed income allocation for 401-k investors from age 60 to 64 was 43%, from age 65 to 69 was 50%, and older than age 70 was 57%. This group of investors is in the pre-retirement and retirement phase and is usually risk-averse in order to stabilize their projected withdrawal stream of retirement income.

Clearly, the large fixed income allocations are targeted to reduce the volatility of their portfolios based on the historically lower expected volatility and drawdown of bonds compared to equities. The current low level of interest rates, however, almost assures that bond total returns over the medium term will be mathematically consistent with the current low yield levels of between 1.5% and 2% (See Davis, Aliaga-Díaz and Patterson) with the potential for negative returns. This combination of low risk and low return with the potential for negative returns and limited upside does little to ease the psyche of this class of investor.

Is there a better investment choice for this class of investor? How can the risk-averse investor shift their investment allocation to achieve assured positive returns while protecting the downside?

401-k plans typically have a range of investment choices, including active and passive stock and bond funds, as well as "target date funds" that automatically shift the stock/bond asset mix from risky stocks to less risky bond weightings as the target date approaches and is surpassed. Core bond allocations in this framework typically mirror the profiles of the AGG ETF. Though not universal to all 401-k plans, many plans also have investment options named Stable Value Fund or Guaranteed Investment Contracts ("GICs) that are comparable in structure to bank certificates of deposit (though with much higher rates as seen below). They accrue interest at a guaranteed rate that is declared each month with a guarantee of principal, but without a stated maturity date. As will be seen below, these stable value options are currently priced very attractively as a less risky bond option.

The Vanguard Retirement Savings Trust II (VRST II) is part of a series of stable value investment options that Vanguard markets to 401-k plans. The Trust II is large at $5.2 billion and other trusts are also available. These funds are not available to regular taxable investors.

The following table compares the VRST II to the AGG ETF. Most obviously, it is instructive to observe the very low volatility of return of the VRST II compared to AGG with VRST II generating a stable ~2% Annual Return each year since 2012 compared to the up and down volatility of AGG. Since 2012, AGG has generated a 3.00% Annual Total Return compared to 2.15% for VRST II, but at a much larger standard deviation (more risk). The Return per Unit of Risk of AGG is much lower at 0.8% compared to 5.0% for VRST II, making VRST II the obvious choice for some risk-averse investors. Also, for retirees actively taking withdrawals, it can be seen that the VRST II 2.07% SEC yield is higher than the 1.72% SEC yield of AGG and currently supports a 2% annual withdrawal rate with no risk of eating into principal due to potential negative returns that AGG could be subject to.






YTD Aug. 2016

Annual Total Return

Standard Deviation

Return per unit of Risk

SEC Yield





















Sources: iShares, Vanguard

Stable value funds are not perfect. For example, there is credit risk if the underlying contract issuer (typically an insurance company) defaults on the underlying contract guarantees, but these contracts are typically issued by highest-rated insurance companies. Also, the current market environment could change and these stable value options could trend to be less competitive on a risk and return basis, so it is important to not simply buy and hold, and to periodically monitor these allocations.

For risk-averse investors, the best features of stable value options like VRST II are undoubtedly the principal guarantee combined with current superior SEC yield compared to AGG, and very low volatility (standard deviation). Swapping AGG-like allocations for VRST II seems like a no-brainer in this market environment for some risk-averse investors.

This article was written by

Tony Ash profile picture
Launched registered investment advisor in September 2018 with CPA partner to provide customized investment planning and portfolio management to high net worth individuals, individuals, families, trusts, businesses, and charitable and other institutions.Previously, Managing Director at start-up investment advisor, Julex Capital Management, developing and marketing dynamic asset allocation ETF Managed Products.  Previously, as head of U.S. Portfolio Management for Sun Life Financial for 12 years, actively directed client-focused portfolio management for $37 billion in insurance company investment portfolios to maximize risk-adjusted return.  BA Boston College, MBA Boston College, CFA Charterholder earned in 1989.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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