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After String of Good Years, Stable Value Funds See Opportunities, Challenges

Stable value funds have held a healthy share of retirement plan dollars through the first five years of this decade. Equal to just 17.5 percent of plan assets at year-end 2000, it jumped as high as 27.1 percent by year-end 2002 and was still holding at 22 percent of plan assets as of November 2005, according to the Hewitt 401(k) Index. The index tracks assets in the 401(k) plans managed by Hewitt Associates, a large defined contribution plan recordkeeper. The popularity of stable value funds during this period has been attributable not only to volatility in the stock market-which tanked badly in 2000 and 2001-but also to a favorable interest rate environment in which stable value returns have handily outpaced those for money market funds and CDs. With short-term interest rates on the rise now-the Federal Reserve Board on November 1 raised the Federal Funds rate 25 basis points to 4 percent, and hinted that more increases could be in the offing-stable value fund managers are bracing for a possible change in market conditions that could impact not only how they manage their funds but also how investors perceive them.

Should interest rates continue higher quickly, stable value investors could be disappointed in the short term. "If we continue to get Fed Fund rate increases," said Tony Camp, vice president of ING's Stable Value Product Group at the SVIA Forum, shortly before the Fed's last move, "it will get retirement plan participants thinking that rates are moving up. They will wonder why their stable value rate isn't moving up in lockstep." Returns on stable value funds don't move up as quickly in a fast-rising rate environment as market rates, of course, but they don't move down as quickly in a fast-declining rate environment, either. The crediting rate formulas used to determine their payouts tend to smooth short-term interest-rate volatility.

Even as they contend with a changing rate environment, Camp said, stable value managers recognize that they've got increasing competition for the average investor's wallet in the form of college tuition plans, Roth IRAs, personal debt, Health Savings Accounts and Health Reimbursement Accounts.

Of course, other factors could work to keep investors in their stable value funds. With the first wave of Baby Boomers reaching retirement age, they may be eager to include more conservative investment options, such as stable value funds, in their retirement portfolios. And because stable value funds are no longer available in mutual fund form in the IRA market, some retirees who might have been expected to swap money out of their 401(k) plans and into an IRA might now leave it there, where they can still get access to stable value investments.

From a money management perspective, stable value managers will be keeping a close watch on the overall health of the bond market should the rate environment turn volatile. Many stable value funds consist of a portfolio of bonds backed by a book-value guarantee, or wrap contract.

"This is probably not a good time to reach for yield," said Camp, a sentiment echoed by Susan Graef, a principal and fixed-income portfolio manager with Vanguard Group. Antonio Luna, a fixed-income portfolio manager for T. Rowe Price Trust Company and co-manager of the T. Rowe Price Stable Value Common Trust Fund, also echoed that sentiment. "In our shop," he said, "we're trying not to be too cute. Not too long ago, credit spreads (spreads between US treasury bonds and other bonds) were wide. Now, squeezing out alpha is tougher. We're spreading our bets across many different strategies."

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