Looking under the stable-value fund hood

Galliard Capital Management Inc.'s stable-value funds, designed to preserve principal in tumultuous times, drew more than four times the usual inflows in August as market volatility increased, said managing partner John Caswell. Investors in retirement plans administered by Wells Fargo & Co. moved $850 million into the funds that month, while at Aon Hewitt, a benefits manager, about $1 of every $5 transferred by plan participants was put in a stable-value fund. While the funds recently have outperformed the stock market, investors should realize they're riskier than money funds, and may contain restrictions on transfers and withdrawals, said Jeff Elvander, chief investment officer for 401(k) Advisors Inc., a consultant to employers that offer defined-contribution plans. “Some of those restrictions may not be clearly communicated until a participant tries to make a transaction, and then they're prevented from making it,” Mr. Elvander said. Stable-value funds are viewed by many investors as a higher-yielding alternative to money market funds, said Pamela Hess, director of retirement research at Aon Hewitt. In August, they returned 0.22%, compared with a 5.68% decline in the S&P 500. The funds achieved those returns in part by purchasing insurance contracts, which come with restrictions.

NO GUARANTEES

The restrictions and complexity mean that stable-value and money market funds aren't really comparable investments, said Donald Stone, president of Plan Sponsor Advisors. “There's a reason why they call them stable value, not guaranteed,” he said. “I don't think participants understand that. They understand if they put a dollar in, they'll get a dollar back, and some interest.” Although they're often called “funds,” stable value can refer to funds that pool one or more retirement plans' assets, and to insurance contracts, in some cases annuities, that are offered within defined-contribution retirement plans such as 401(k)s. The funds generally invest in short- to intermediate-term bonds and buy insurance on their portfolios. The contracts are issued directly to a retirement plan sponsor or to its participants, and offer an interest rate that resets periodically.

SMOOTH RIDE

By buying insurance on their portfolios, the funds can allow investors to redeem shares at principal plus interest, even though the underlying bonds may be lower or higher in price. The insurance is meant to cover a potential shortfall should a fund have to sell bonds to meet redemptions. “The insurance smoothes out the returns of the underlying portfolio,” said Gina Mitchell, president of the Stable Value Investment Association, a membership and trade group for the stable-value industry. The insurance also comes with restrictions. The companies that provide the contracts, including Prudential Financial Inc. and JPMorgan Chase & Co., generally limit the circumstances under which they'll pay out, and also may restrict how or when savers may transfer or withdraw their money. “The insurance company is willing to guarantee this book value, but they're only willing to do that up to a point,” Mr. Stone said. Investors usually can't move their money to competing investment options such as short- to intermediate-term-bond funds for 90 days after withdrawing from a stable-value option, said Mr. Caswell.

SURRENDER CHARGES

The insurance contracts can be even more restrictive. Savers in a stable-value annuity issued by TIAA-CREF may withdraw or transfer funds only in a set schedule of 10 payments over nine years. Workers who quit a company that uses the product in its retirement plan may take a lump sum within their first 120 days of leaving, during which they would pay a 2.5% surrender charge. Retirement plan administrators such as Fidelity Investments said these restrictions are disclosed in investment literature, but participants don't always read it. Those limitations allow TIAA-CREF to offer a higher interest rate than it would otherwise, said Phil Maffei, director of product management for the insurance and mutual fund provider. The TIAA-CREF annuity yielded 4% in August. There was about $540 billion invested in stable-value products as of December, according to the Stable Value Investment Association.