Stable value 2.0, fewer investor guarantees

Wed Apr 11, 2012 2:52pm EDT

* New iterations make it harder for plans to get money back

* Fewer guarantees on principal investment for participants

By Jessica Toonkel

NEW YORK, April 11 (Reuters) - Stable value funds have long been a go-to conservative investment for many 401(k) plans, offering a guarantee on principal and an easy out for companies that want to switch funds. But those benefits are disappearing.

Insurers who guarantee the principal in these funds have significantly limited the type of investments they will insure in the last several years.

Fund providers such as J.P. Morgan Asset Management and Pacific Investment Management Co, have responded by offering stable value funds that no longer guarantee principal or make it harder to get out of funds quickly. Some 401(k) plans have switched to funds that only guarantee a portion of a participant's investment, exposing them to the market volatility the funds used to shield them from.

"Stable value funds are turning into plain bond funds where investors are paying ... for insurance that might not have any value," said Lori Lucas, the defined contribution practice leader for Callan Associates.

It's a stark contrast from the stable value ethos that has existed for the better part of four decades, leaving some industry observers wondering if the new iteration of the funds is worth the investment. The trend, if it continues, could mean less flexibility for plan sponsors and fewer guarantees for investors.

"These products are not as good as they used to be," said Don Stone, managing partner of Plan Sponsor Advisors LLC, a Chicago-based adviser. But with money market funds returning close to zero, 401(k) plans have few other options for cash preservation with yield, he said.

CHANGING THE TERMS

Stable value funds, which on average return two to three percent, are offered in 80 percent of the largest 401(k) plans, according to Aon Hewitt. They are available in 59 percent of large and mid-sized plans and make up an average of 21 percent of plan assets, according to Callan Associates.

For years, the bank and insurers -- also known as wrap providers -- guaranteed principal in the funds. These funds were mostly made up of bonds with a duration of two to three years.

But during the financial crisis the market value of many stable value funds dipped below the book value guaranteed by insurers, exposing the risks wrap providers faced, said James King, head of Prudential Financial Inc's stable value markets group and chairman of the Stable Value Investment Association. If investors or plan sponsors wanted to cash out, these firms were on the hook for the principal.

After the crisis, wrap providers and fund managers set new conditions for stable value funds, including stricter investment guidelines for what insurers will guarantee and even shorter durations for investments.

J.P. Morgan, for example, once had up to 13 percent of its $1.7 billion Stable Value Income Fund invested in less-liquid private mortgage debt that wrap providers are now loathe to insure. It has been slowly shedding that investment after insurers balked.

Wrap providers also raised their rates to 20 to 25 basis points, up from about eight basis points five years ago.

Peter Chappelear, head of JP Morgan Asset Management's $21 billion stable value business, said the changes make it difficult to offer traditional stable value funds. A few firms, like Charles Schwab Corp and Old Mutual Asset Management, got out of the stable value business altogether.

In February, J.P. Morgan, part of JPMorgan Chase & Co, removed a provision in its stable value fund that had allowed 401(k) plan sponsors to exit the fund and get their principal back within 12 months -- even if the market value was lower than the book value. Now, employers can get their money back in 30 days, but only at market value.

PIMCO, meanwhile, introduced a new Stable Income Fund that doubles the standard 12-month return of money -- called a put option -- but still guarantees the principal. The change allows PIMCO to invest in longer duration securities again --potentially generating a better return - and allows insurance providers to spread their risk over a longer period, said John Miller, head of PIMCO's U.S. defined contribution and retirement business.

Fidelity Investments is also offering cheaper stable value funds that only guarantee a portion of a 401(k) plan participant's investment. Fidelity offers this option to a "small number of plan sponsors," a spokesman said. J.P. Morgan has discussed it with clients but none are using it so far.

Plan advisers and consultants say keeping stable value funds as a 401(k) offering could be a bad move if the fund company might eliminate or extend the fund's put option.

"I would get out of the plan if I knew I could get the money out at book value now," said Chris Tobe, founder of Stable Value Consultants, in Louisville, Kentucky.

So far there is little evidence that is happening. Of the 250 401(k) plans in the J.P. Morgan fund, only two have terminated, according to the firm.

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