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401(k) Investors Flock to Stable Value Funds

Stock market returns have been miserable for the past two years; making the gains posted by Stable Value funds look positively stellar. Nonetheless, vendors who advise retirement plan investors on where to stash their money say their computer models aren't recommending Stable Value funds any more frequently than they did in the past.

"One of the characteristics of our advice framework is that we're not trying to help participants arbitrage the difference between market rates (of return) and the crediting rates of Stable Value funds-time the market, if you will," says Chris Jones, executive vice president, financial research and strategy, for investment advisor Financial Engines. "What that implies is that the allocations we recommend into fixed income versus equity versus Stable Value or any other investments tend to be quite stable through time." Dave Goerz, chief investment officer for advice provider mPower, concurs. "The amount that we would recommend for a given individual to allocate to Stable Value hasn't changed," he says. "It's the same as it was two years ago."

Both mPower and Financial Engines advise participants in employer-sponsored retirement plans on how to allocate their retirement funds among different asset classes, and among available investment options within those asset classes. Investors typically access the advice services via the Internet, although some plan providers have begun to make advice available via call centers and even through face-to-face meetings between plan participants and financial advisors. In their earliest incarnations, the online advice services drew considerable criticism from Stable Value professionals, who argued that the services didn't accurately model the risk and reward characteristics of Stable Value funds. By the end of 2001, however, the leading providers had made notable improvements to their Stable Value modeling capabilities, and both mPower and Financial Engines say they haven't felt compelled to introduce any significant changes since then. Goerz acknowledges that mPower did make one change to its methodology last year, incorporating into its model an analysis of each fund's underlying exposure to credit risk.

While advice engines may not be cranking out bigger recommended allocations to Stable Value, many retirement plan investors are flocking to Stable Value funds anyway, dismayed by the losses chalked up by their equity investments. In 2001, the Standard & Poor's 500 stock index posted a total return of -11.9%, a disappointing performance that it topped in 2002 by posting a total return of -22.1%. By contrast, the Hueler Analytics index of pooled Stable Value funds, which tracks the performance of some $59 billion in pooled Stable Value assets, earned 6.2% in 2001 and 5.6% in 2002.

If investors at large are flocking to Stable Value funds in spite of "stay the course" recommendations by advice providers, it may be because eight years after mPower debuted the first online advice service-the company was called the 401(k) Forum back then-only about 5% of the nation's 60 million retirement plan investors have actually tried the services, estimates Neal Ringquist, mPower's executive vice president. Investors who do use the services, adds Jones, are less likely to make dramatic changes in their retirement portfolios than investors who do not, since those who've received advice are more likely to understand that investing for retirement is a long-term undertaking generally ill served by efforts to time the market.

Financial Engines' Jones notes that some investors who in years past had indicated they had a high tolerance for risk-one of the factors that influences the advice they receive-have changed their profiles over the past year or so to accept less risk. That has led to recommendations for more diversified portfolios, including, it would stand to reason, greater allocations to fixed-income investments. "Primarily, that seems to have been people who had a very heavy concentration of company stock in their portfolios or a very heavy allocation to growth-oriented equity funds," Jones says. "They have backed away from that and are now holding more diversified portfolios relative to what we saw three years ago, though it would be rare to have seen someone dump all of their other investments in favor of Stable Value."

That said, the investment behavior of 401(k) participants as a whole has been fairly dramatic of late. According to data compiled by the research and consulting firm Hewitt Associates, approximately 95% of all transfers within the 401(k) plans included in its Hewitt 401(k) Index last year flowed out of stock investments and into one of three fixed-income categories: money market funds, bond funds, or GIC/Stable Value funds. Early in the year, bond funds attracted most of the transferred assets. From May through August, bond funds and GIC/Stable Value funds both drew large volumes of transferred assets, but beginning in September GIC/Stable Value funds began to attract the lion's share of transferred assets. In the first month of 2003, the disparity was overwhelming: 79.8% of all transferred assets flowed into GIC/Stable Value funds, versus just 6.3% into money market funds and 7.5% into bond funds. The money that flowed into these asset classes came from sales of equity funds of all types, but particularly large-cap US equity funds, which had a negative outflow of 34.9%, and company stock, which posted a negative outflow of 25.5%.

Transfer activity within 401(k) plans typically reflects the activity of only a small portion of plan participants, since the vast majority of 401(k) investors never move money once it's in their plan. However, another measure of how investors view Stable Value funds is the degree to which they allocate new contributions to them. Here, the Hewitt 401(k) Index data indicates that in January 2003 investors allocated 22% of new contributions to GIC/Stable Value funds, up from 17.1% in January 2002 and 12.5% in January 2001. By contrast, contributions to US equity funds accounted for 29.4% of total contributions in January 2003, down from 38% in January 2002 and 39.5% in January 2001.

The flow of new money into Stable Value funds over the past two years, combined with the superior returns being generated by Stable Value relative to equity funds, has resulted in a dramatic up tick in the percentage of retirement plan assets held in Stable Value investment products. According to the Hewitt 401(k) Index, GIC/Stable Value funds accounted for 27.7% of 401(k) assets in January 2003, up from 20.4% in January 2002 and 17.4% in January 2001.

Going forward, both mPower's Goerz and Financial Engines' Jones say the degree to which investors allocate money to Stable Value funds could be impacted slightly by President Bush's proposal to eliminate federal income taxes on stock dividends, assuming that proposal is adopted by Congress. If it is, says Jones, dividend-paying stocks would become more tax-efficient than they were in the past which would make them more attractive for taxable investment accounts. That being the case, investors who have sizeable investment holdings outside of their retirement plans, and who seek advice on those investments as well as their retirement plan assets, could get recommendations to change which assets they hold in their tax-deferred retirement plan and which they hold in their taxable accounts. Indirectly, Goerz adds, the tax cut could be viewed as a stimulant for the economy, which would be good for equities and would mean that "on the margin, the outlook for equities would be improved somewhat on an after-tax basis. This, in turn, would lower the required equity risk premium in a way that would make individuals more inclined to invest in equities" versus other asset classes. This would not be an issue, of course, for the majority of retirement plan investors who don't hold investment assets outside those plans.

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