- Interest-rate increases in 2022 affect certain stable value investments differently
- Putnam Stable Value Fund has diversified strategies and relies less on synthetic Guaranteed Investment Contracts (GICs)
- We plan to manage the fund with a consistent approach
With the Federal Reserve likely to raise the federal funds rate multiple times during 2022, it is worth considering the potential impact on a range of fixed income investments. We want to offer this outlook for the stable value asset class and specifically Putnam Stable Value Fund, with details on how specific stable value investment types react differently in a rising rate environment.
The effect of rising rates on stable value investments
All stable value funds utilize, to varying degrees, synthetic GIC strategies. These consist of an underlying portfolio of bonds and wrap contracts to provide book value protection for participants. Within a synthetic GIC, crediting rates and market-to-book ratios fluctuate as interest rates move up and down. As interest rates rise and bond prices fall, the crediting rates on synthetic GICs will adjust to reflect the lower market values of bond holdings. The crediting rate formula takes the difference between market value and book value (positive or negative) into consideration as an input during the crediting rate reset process.
Depending on the speed at which rates rise, synthetic strategies may be unable to capture enough of the rate rise to compensate for declines in the market-to-book ratio. This may result in a lower crediting rate for a period of time, until higher yields eventually balance out the decline in underlying market value. As a reminder, the crediting rate mechanism is designed to bring market value (MV) and book value (BV) closer together over time. Therefore, a lower MV/BV ratio causes the associated crediting rate to fall.
Depending on the speed at which rates rise, synthetic strategies may be unable to capture enough of the rate rise to compensate for declines in the market-to-book ratio.
Other stable value investments include cash strategies and traditional GICs. Cash, which typically includes money-market-like funds and other short-term holdings, quickly reflect interest-rate moves with no associated loss in market value. Meanwhile, the value of traditional GICs does not fluctuate with interest-rate changes, as they are held at book value (100%) throughout the life of the contract. Additionally, the crediting rate of a traditional GIC, unlike that of a synthetic GIC, stays the same throughout its life.
Putnam Stable Value Fund uses strategies seeking stability
Putnam Stable Value Fund employs four distinct strategies, two of which have no sensitivity to changes in current market interest rates (in terms of their underlying value): cash holdings (which all stable value funds have, to a degree) and the traditional GIC component. Both are carried at book value. Money market and short-term holdings immediately reflect new rate movements with no loss in value. Similarly, as mentioned, the associated crediting rate and book value for traditional GICs do not fluctuate with interest-rate changes. As a result, these two strategies (which combined represent approximately 30% of Putnam Stable Value Fund as of December 31, 2021) provide additional stability to the fund’s market-to-book ratio and overall portfolio crediting rate.
Putnam Stable Value Fund employs four distinct strategies, two of which have no sensitivity to changes in current market interest rates.
Also, our liquidity-focused structure generates scheduled maturities at par each quarter, and these can be re-invested at current market rates. This allows the portfolio to generate income more in line with the current interest-rate regime without having to sell existing assets, in turn supporting the fund’s crediting rate.
Maintaining a consistent approach in a rising rate environment
We manage the Putnam Stable Value Fund as a long-term strategy, striving to provide consistent returns regardless of the rate environment. Therefore, we do not plan to make any significant changes to the portfolio structure as the interest-rate regime changes. It is also worth noting that we generally do not take large term structure (also known as duration) bets in the portfolio. Stable value is an absolute return product, relying less on relative returns to a specified market benchmark and more on the return versus alternative capital preservation strategies, such as a money market fund. We expect to generate alpha primarily through sector rotation, security selection, and capitalizing on yield differential opportunities between traditional GICs and synthetic strategies.
Learn more about Putnam Stable Value Fund and its use of traditional GICs at Putnam.com/dcio.
For informational purposes only. Not an investment recommendation.
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Diversification does not guarantee a profit or ensure against loss. It is possible to lose money in a diversified portfolio.
Consider these risks before investing: International investing involves certain risks, such as currency fluctuations, economic instability, and political developments. Investments in small and/or midsize companies increase the risk of greater price fluctuations. Bond investments are subject to interest-rate risk, which means the prices of the fund’s bond investments are likely to fall if interest rates rise. Bond investments also are subject to credit risk, which is the risk that the issuer of the bond may default on payment of interest or principal. Interest-rate risk is generally greater for longer-term bonds, and credit risk is generally greater for below-investment-grade bonds, which may be considered speculative. Unlike bonds, funds that invest in bonds have ongoing fees and expenses. Lower-rated bonds may offer higher yields in return for more risk. Funds that invest in government securities are not guaranteed. Mortgage-backed securities are subject to prepayment risk. Commodities involve the risks of changes in market, political, regulatory, and natural conditions. You can lose money by investing in a mutual fund.
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