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Killing It Softly

Under departing Chairman William Donaldson, the SEC generated plenty of noisy headlines. But one of the Commission's most decisive actions received little attention; it recently eliminated a class of investments: stable value mutual funds. Stable value funds, used for years by institutional investors, attracted retail money scarred by a bear market, because it guaranteed its NAV, plus paid decent

Under departing Chairman William Donaldson, the SEC generated plenty of noisy headlines. But one of the Commission's most decisive actions received little attention; it recently eliminated a class of investments: stable value mutual funds. Stable value funds, used for years by institutional investors, attracted retail money scarred by a bear market, because it guaranteed its NAV, plus paid decent interest. By April 2004, there were eight stable value mutual funds with $6.6 billion in assets. Now the group is completely gone. The SEC never issued an official ban. Instead, regulators dropped the boom quietly.

The funds invest in portfolios of short- and intermediate-term bonds, the same kind of investments that are held by common bond mutual funds. To hold their values constant, stable value funds buy contracts from insurance companies (“wrappers”). If the value of a fund's portfolio dips, the wrapper steps in. The use of wrappers in the mutual funds was what raised eyebrows at the SEC. Some SEC staffers worried that the constant figure could be misleading, that funds could lose money if insurance companies failed.

Stable Value Limits Risk
Stable value funds avoid downturns, and almost keep pace with conventional bond funds
5-YEAR TOTAL RETURNS
Stable Value index* 5.26%
Morningstar short-term bond funds 5.77%
Lehman Brothers 1-3 Year Government Bond Index 4.80%
iMoneyNet All Taxable Money Market Index 2.25%
*Stable value data from Gartmore Morley Financial. Returns through 3/31/05.

Yet, institutional stable funds are still thriving, mainly in 401(k) plans. The banning of the class of mutual funds has left some in the industry grumbling. No stable value funds had run into trouble, and now retail investors may head into riskier choices. Instead of ending the funds, the SEC should have tightened investment standards, says Morningstar.

Should you steer clients to stable-value choices in 401(k) accounts? There is no reason not to. The funds offer a steady way to get fixed-income exposure and diversify a portfolio.

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