Guaranteed investment products, including stable value funds, guaranteed investment contracts (GICs), and synthetic GICs, are offered in many defined contribution plans in the United States. According to “Estimating Credit Risk and Illiquidity Risk in Guaranteed Investment Products,” they appear to have low risk, but since the returns are based on rules and formulas rather than marked to market it can be hard to tell.
As an example, the paper notes that the coupon payments associated with Lehman Brothers-issued structured products had no volatility until Lehman’s bankruptcy in 2008.
Traditional methods for comparing products and constructing optimal portfolios, i.e. looking at return and risk (standard deviation), underestimate the risk of guaranteed products and lead to over-allocation. The researchers estimate that the true standard deviation for guaranteed products should generally be about one to five percentage points higher depending on the product structure, liquidity terms, and financial strength of the insurance company issuer. These higher standard deviations make the risk profile of many guaranteed products more similar to domestic bonds than cash.The paper can be downloaded from http://www.fpanet.org/journal/EstimatingCreditRiskandIlliquidityRisk/.