By JASON ZWEIG
Stable is nice, but it isn't perfect.
Investors in "stable-value funds," which are bundles of bonds tied together with an insurance policy within a 401(k) retirement plan, have fared remarkably well in recent years. But rising fees, falling interest rates and reduced flexibility make the funds a bit trickier than some might realize.
While the stable-value category isn't "hot," it is definitely warm. According to the Aon Hewitt 401(k) Index, which tracks retirement plans with approximately $120 billion in assets, some $1.6 billion moved out of stock funds this year. Three-fourths of that went to stable-value funds.
These vehicles are attracting new money because of their safety. Whenever their market value falls below book value (typically $1 per share), the insurance enables anyone withdrawing money to receive the full book value plus interest.
Thus the funds protect against loss while providing steady income -- appealing when the Dow Jones Industrial Average heaves up and down by hundreds of points a day.
Investors have known this for a long time. The funds, which have been around since the 1970s, hold more than $600 billion in assets, estimates Christopher Tobe of Stable Value Consultants in Louisville, Ky. Investors in 401(k) plans have more money in stable-value than in bond funds.
According to BrightScope, a firm that analyzes retirement accounts, nine plans with more than $1 billion have more than half their assets invested in stable-value funds. At DuPont (DD),
Stable-value funds have proven their resilience. When Lehman Brothers failed during the financial crisis, its employees lost 1.7% in December 2008 on their stable-value fund. But the same fund still earned 2% for the full year. No other stable-value fund in a 401(k) fell below $1 or failed to deliver its promised yield, even as stock investors lost 37% in 2008.
There are a few concerns on the horizon, however.
First, costs are creeping up. "Wrap fees," or the cost of the insurance, have gone from roughly 0.08% a few years ago to as much as 0.20%, says Gina Mitchell, head of the Stable Value Investment Association.
Those fees are rising even as yields are falling. The average "crediting rate," or expected yield, ran at 2.99% in the third quarter, reckons the SVIA. That's far higher than the 0.05% on the average money-market fund and exceeds the 2.4% yield on the Barclays Capital U.S. Aggregate bond index.
But the crediting rate has fallen by a quarter of a percentage point in the past year and is down from 4.05% three years ago -- generating less income today, especially after inflation. Since the end of 2008, the yield on intermediate U.S. Treasurys has dropped to 0.82% from 1.25%.
And, just like homeowners' insurance, stable-value coverage doesn't eliminate every risk. "There are protections written into the contracts that could get the [insurer] out of the obligation to provide a guarantee," says Mitchell Shames of Harrison Fiduciary Group, a financial firm in Boston. For example, if a company initiates massive layoffs or an external manager violates investment guidelines, the insurance provider could decline to make employees whole on their stable-value funds.
While employers work hard to insulate their funds against those hazards, says Mr. Shames, the risk of losing coverage remains a possibility. On the other hand, he says, "you get compensated for that risk in terms of the added return" over short-term bond funds.
And while it's never been easy to exchange from stable-value options into other funds, restrictions appear to be growing more common as insurers seek to cut costs, says Peter Schmit, a research manager at Towers Watson, the benefits-consulting firm. Under "equity wash rules," you can't transfer straight from a stable-value fund to a money-market fund but must park your money in a stock fund (or sometimes a bond fund) for at least 90 days.
That could crimp your style if interest rates rise steeply. At the typical stable-value fund, the income credited to investors changes only quarterly. So, if rates go up, your income will stand pat for as long as 90 days, even as the yields on money-market and short-term-bond funds rise with higher rates in the marketplace.
The lag in adjusting to rate changes can "work against you on the way up," says Susan Graef, whose group manages $28 billion in stable-value assets at Vanguard Group.
With these caveats, stable-value funds remain a solid option for conservative investors. But your expectations for these funds shouldn't be stable; you should be lowering them.—email@example.com; twitter.com/jasonzweigwsj