Funds still beating competitors in retirement plans

Stable value continues to be a winner, outperforming numerous strategies and asset classes. That's according to David Babbel of The Wharton School at the University of Pennsylvania and Miguel Herce of Charles River Associates, two experts on stable value fund performance since the 1970s. The pair recently updated their economic literature on stable value performance through December 2009, which they released in January. Stable value funds were created in the late 1980s, although earlier forms of stable value funds have been around since the early 1970s, coinciding with the development of U.S. defined contribution plans. The returns have always been fully guaranteed by insurance contracts regardless of the performance of underlying assets in the portfolio.

They typically invest in high-quality, short-maturity – usually under five years – corporate and government bonds, mortgage-backed securities and asset-backed securities, and are protected by so-called wrap contracts, which guarantee book value in case of redemption. "From an investor's viewpoint, stable value funds operate like a passbook savings account," said Mr. Babbel and Mr. Herce. "They accrue interest at a prespecified rate that is generally updated every one to three months to incorporate changing market conditions. Their principal is secure and grows over time by the amounts of interest credited to their account."

Looking at the data through December 2009, which include the financial crisis years, stable value funds have shown they can provide higher returns and lower volatility than their closest competitors, money market funds and intermediate-bond funds.

"With very few exceptions, they appear to have weathered the recent financial crisis of 2007-2008, even while the number of wrap providers dwindled briefly from 25 to less than a dozen, precipitating steep increases in wrap fees among those remaining," the research found. These exceptions included the Lehman Brothers bankruptcy, which resulted in a small monthly decline in fund value of 1.7% in December, albeit an overall positive return of 2% over the year. "By 2010, the number of wrap providers had increased again, including some new entrants."

Mr. Babbel and Mr. Herce added that at the height of the financial crisis in December 2008, the average market value of assets dipped to as low as 95% of their book value, but a year later climbed to 101% and by September 2010 had reached 104%. "The 95% ratio of December 2008 was an aberration, as historically market-to-book ratios have ranged from 96% to 104%," according to their research. A few funds exhibited market-to-book ratios below 90%, but they have been worked out and these managers had issues specific to their funds.

One interesting thing their research found is how quickly market values of stable value funds that dropped during the crisis bounced back. This phenomenon is explained in part by their short duration and high credit quality, which allowed for a quick recovery. The fact that 401(k) investors flew to the safe haven of stable value funds during the financial crisis also contributed to their fast and prompt recovery.

As a result, members of the Stable Value Investment Association reported average yields as of June 30, 2010, in excess of 3% per annum, while intermediate-term government bond yields, at 1.4%, were less than half of that level, six-month bank certificate of deposits averaged 0.3% and money market rates still hovered over zero. Stable value funds continue to prove their resilience. "Their stability, predictability and preservation of principal help to foster consistent savings habits, which can add a measure of confidence among savers as they prepare for their future needs," Mr. Babbel and Mr. Herce concluded.