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Investors, Managers Keeping the "Stable" in Stable Value

Despite a volatile economy, financial markets and world political stage, stable value investments have provided steady and consistent returns to their investors over the past five years. Even as returns on money market funds were slipping below one percent and intermediate bond funds were bouncing around like a rubber ball-the Lehman Brothers Intermediate Government/Credit fixed-income index earned 0.4 percent in 1999, 10.1 percent in 2000, then slumped in each of the next three years until it posted a return of 4.3 percent in 2003-returns on stable value funds motored along smoothly, easing from about 6.5 percent in 1999 to about 5 percent this year.

Part of that steady performance is attributable, of course, to the structure of stable value funds. By virtue of their book value accounting methodology, stable value funds smooth out the ups and downs that plague ordinary intermediate-term bond funds. But their steady performance also reflects the behavior of investors and stable value managers over the past five years.

The chief risk to stable value funds in volatile markets is that investors will bail out of the funds when competing investments, such as interest-rate sensitive money market funds or even the stock market, are rising rapidly. Especially during periods of rapidly rising interest rates, this could force stable value managers to liquidate some of the fixed-income assets in their portfolios to meet shareholder redemptions at exactly the time the value of those assets has been compromised. This, of course, would reduce returns for the remaining investors in the fund.

As it happens, few investors have tried to trade in and out of stable value funds to exploit other short-term opportunities over the past five years. Addressing SVIA's Forum, Doris Fritz, Vice President in the Investment Services Consultant Group for Fidelity Investments, reported that among the more than eight million participants enrolled in defined contribution plans for which Fidelity provides recordkeeping services, only 13 percent transferred any of their money from one fund to another in 2003. Among that slim minority that did make changes, most-58 percent-did so on only one day of the year, and only two percent made exchanges on four or more days.

It is true, of course, that stable value assets as a percentage of total assets in retirement plans fluctuated quite a bit over the past five years. According to the Hewitt 401(k), stable value investments accounted for 19.9 percent of the assets in 401(k) funds at year-end 1999, shot up to 27 percent by the end of 2002, then backtracked to 23.2 percent by the end of last year. But much of that volatility had to do with the performance of the stock market. As stock prices plunged from 2000 to 2003, reducing the value of stock funds held in retirement plans, the percentage of plan assets represented by stable value funds increased, in part, by default. Through most of that time, contributions to stable value funds rose only moderately. In December 1999, for example, investors in the 401(k) plans tracked by Hewitt were steering 19.4 percent of new contributions into stable value products; by year-end 2002, that figure was just a bit higher at 21.5 percent.

Richard Taube, Assistant Vice President for Institutional Products with Pacific Life Insurance Company, says stable value managers have been similarly steady in managing their investment portfolios. Pacific Life provides wrap contracts that insure the book value guarantee promised by stable value funds. As such, it has a keen interest in knowing whether or not its clients-stable value managers-are adding more volatile investments to their portfolios in a bid to capture higher returns. "We don't see people pushing the limits," Taube told the SVIA Forum. "The vast majority of managers have extended the duration of their portfolios over the past year," he said, "but on average only by about 0.2 years." (Extending the duration of a portfolio typically allows managers to capture higher yields on their bonds, but at the expense of greater volatility.) While some managers increased the duration of their portfolios by as much as one year, Taube noted that some actually shortened their fund's duration.

Given the behavior of stable value investors and managers during the market gyrations of the past several years, Taube said he expects those managers to "keep stable value stable" in the years ahead, too.

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