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Assets in Stable Value Mutual Funds Pass $1 Billion Mark

Stable value mutual funds are finally gaining traction. Roughly four years after Bankers Trust launched the first such fund there are now more than half a dozen, with total assets exceeding $1.3 billion. While that’s a pittance compared to the $3.3 trillion in stock funds, $2.3 trillion in money market funds and nearly $1 trillion in bond funds, it’s not pocket change, either. And with the stock market sluggish and money market returns at historic lows, stable value funds seem poised for continued growth.

“Product awareness is still a big issue, particularly with financial advisors in the IRA market,” says John Axtell, managing director and head of the stable value group at Deutsche Asset Management, the asset management arm of Deutsche Bank, which acquired Bankers Trust in 1999. “But we’ve been doing a lot in terms of putting on seminars for both financial advisors and the press, and what we’ve seen is that once advisors are made aware of this product, they quickly see its benefits and are very receptive to it.”

Deutsche manages the world’s oldest stable value mutual fund, the Deutsche Preservation Plus Fund, which it markets exclusively to participant-directed retirement plans. It also manages the Deutsche Preservation Plus Income Portfolio, which is marketed to both retirement plans and IRA investors in two forms: as the Deutsche Preservation Plus Income Fund and the Security Capital Preservation Fund. Combined, these Deutsche-managed stable value mutual funds had assets of more than $580 million at year-end 2001. Other managers of stable value mutual funds include Dwight Asset Management (for the PBGH family of mutual funds); ICMA Retirement Corp.; Morley Financial Services, a unit of Nationwide Financial Services Inc.; Oppenheimer Funds and Principal Life Insurance Co.

Growth Factors

Although stable value mutual funds attracted some attention from investors upon launch, interest accelerated in 2000 when the implosion of the tech-stock bubble was followed by a broad stock market downturn, bringing to a close the greatest bull market the US had ever seen. Investor interest intensified last year as the Federal Reserve Board drove down short-term interest rates in a bid to stimulate the economy.

“We started noticing it (increased interest by investors) in early-to-mid 2001, when the Fed started lowering short-term interest rates,” says Axtell. “That made the yields on stable value funds much more attractive than the yields on money market funds and short-term bond funds.” By the end of 2001, stable value mutual funds were still yielding about 6.0%. The average money market fund, by contrast, was yielding about 2.0%, while intermediate-term bond funds were yielding about 4.8%.

Soon, the older stable value mutual funds will have yet another marketing lever: a track record of sufficient length to merit a rating from Morningstar Inc., the influential mutual fund research firm headquartered in Chicago. Morningstar assigns mutual funds one of its risk-adjusted “star” ratings after they have been in operation for three years.

“We just received our Morningstar rating for the Deutsche Preservation Plus Income Fund and got the highest rating, five stars,” says Axtell. “In fact, we have a five-star rating for both of our funds. We expect that kind of recognition to help us even more in our marketing efforts going forward. We expect things to only get better in terms of asset growth.”

Other stable value mutual funds that will soon have three-year track records include the Nationwide Morley Capital Accumulation Fund managed by Morley Financial Services and the Oppenheimer Capital Preservation Fund managed by Oppenheimer Funds. The Nationwide fund was three years old in February, while the Oppenheimer fund will celebrate its third birthday in September.

Distinguishing Features

Not surprisingly, most stable value mutual funds launched to date are similar in structure, investing principally in high-grade short-term and intermediate-term fixed income securities. Most also charge a redemption fee to investors who sell their shares when yields on cash equivalents shoot above the yields on the funds themselves. It’s a prudent measure aimed at discouraging investors from trying to arbitrage rates on those competing products to the detriment of long-term shareholders.

That said, there are some noteworthy differences in the way the funds invest their assets. On the credit-quality scale, for example, Deutsche Asset Management has taken the most aggressive approach with its PreservationPlus Income Portfolio. While the average credit quality of its portfolio is a healthy Double-A, the minimum credit rating at time of purchase for most securities in that portfolio is Triple-B. (Deutsche sets a higher minimum credit rating—Single A—for securities in its PreservationPlus Fund.)

ICMA also permits Triple-B investments in its stable value fund, but Deutsche goes a step further with the PreservationPlus Income Fund by retaining the right to invest up to 10% of the fund’s assets in high-yield, or non-investment-grade bonds. Finally, Deutsche also allocates about 1% of the assets in that fund to a global asset allocation overlay strategy which takes tactical positions, both long and short, in various securities markets around the world. Those markets can include equity futures, fixed income and foreign currency markets. “It’s a very risk-controlled strategy that has added value to the performance of the portfolio while still allowing the portfolio to be covered by the wrap contracts,” Axtell says. (Wrap contracts are the book-value guarantees that insurance companies and other financial institutions sell to stable value managers to ensure that stable value investors won’t lose any of their principal.)

At the other end of the credit-quality spectrum is the PBHG IRA Capital Preservation Fund run by Dwight Asset Management. This fund invests only in securities with a Triple-A rating.

Dwight has also gone against the trend by eschewing any interest-rate triggers for its redemption fee. Instead, it simply levies the charge on investors who hold their shares for less than 12 months. ICMA Retirement Corp., meanwhile, which serves government pension plans and IRA investors who participate in them, puts no restrictions on redemptions from its stable value mutual fund, which is marketed under the name Vantagepoint Income Preservation Fund.

“It’s been difficult to construct this (redemption) fee because of the natural tension that exists between what the retail investor wants, which is no real restrictions, and the requirements of the wrap providers,” says Laura Dagan, Dwight’s chief operating officer and also a member of the team of portfolio managers running the fund. “The problem with the trigger is that it’s complicated and hinders sales. So we’ve worked with our wrap providers to get them comfortable with how we’re going to manage the fund to help protect their interests.”

Dagan declined to discuss the details of how it will do that, but there are a number of ways to provide liquidity during times of rising interest rates, including holding a buffer of cash in the fund’s portfolio. Dagan confirmed that the PBHG fund portfolio does include some cash, along with treasuries, agency bonds, mortgage-backed securities, asset-backed securities and Triple-A-rated corporate bonds.

Yet another approach to portfolio construction has been taken by Oppenheimer Funds, which has structured its stable value product as a fund of funds. According to John Kowalik, senior vice president, portfolio manager and head of investment grade fixed income investments for the firm, the Oppenheimer Capital Preservation Fund holds about 70% of its assets in an Oppenheimer Limited Term Government bond fund; 20% in the Oppenheimer Strategic Income bond fund (a diversified fixed-income offering), and approximately 5% each in an Oppenheimer money market fund and the Oppenheimer Bond fund (an intermediate-term fixed income fund).

Most managers are marketing their stable value mutual funds to IRA investors through established distribution channels, such as broker/dealers, financial advisors, banks, or, in the case of Nationwide and Principal, their own distribution networks. Most are marketing to the defined contribution retirement plan market as well. Oppenheimer, though, has proceeded cautiously in the IRA arena, and only plans to begin marketing there later this year.

The Outlook

Though still occupying a small niche in the mutual fund world, stable value mutual funds are poised for substantial growth, their managers agree.

“Stable value funds have been available to qualified plans and plan sponsors for a long time, and we simply need to get the word out that this asset class, which many Americans have already invested in through their defined contribution plans, is now available to them in a different way,” says Steve Ferber, senior vice president of sales and marketing at Morley Financial. He says he expects his firm’s fund to approximately quadruple in size this year, to about $200 million, now that Morley has beefed up its sales and marketing effort and signed on a number of new distribution partners.

“We need to build on the exposure and familiarity of DC plan participants,” agrees Terry Hotchkiss, a product specialist with Principal Capital Income Investors. “Once those people investing in stable value funds in their retirement plans see they have the opportunity to roll their money into a stable value fund in their IRA, you’ll see it become a popular option there, just like it is right now in DC plans. We also need to build an historical track record showing that our long-term performance is similar to that of an intermediate-term bond fund and over most time periods will consistently outperform money market funds.”

The effort is well underway.

Stable Value Mutual Funds at a Glance

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