Stable value funds - the controversy continues

As markets began to tumble early last year I wrote a couple of posts advocating that workers put a sizable percentage of 401k investments into stable value funds.

This generated some debate as stable value funds are somewhat murky investments. It is difficult to find out exactly what investments are held within the funds and there was some fear regarding the fact that it had been common for these funds to hold Fannie Mae and Freddie Mac bonds, for example. Adding to the apprehension, AIG was one of the companies that was well known for providing insurance (known as a "wrap") for these funds in the event they are not able to generate promised returns and needed to make up the difference. Most investors remember when these companies were in the spotlight and eventually required government bailouts.

Despite all the worry, stable value funds have been quite stable during all the market turmoil of the last year or so. Except for one.

The Wall Street Journal recently wrote about an Invesco stable value fund that lost 1.7% of its value in December. The fund was managed on behalf of Lehman Brothers. This particular fund was hit by falling bond prices. The problem was that some of the insurance coverage or "wrap" ended after Lehman's abrupt mid-September bankruptcy filing. Apparently two of the seven arrangements were discontinued in the confusion surrounding the hurried collapse of Lehman.

So how bad was this? The investors in this stable value fund lost 1.7% of their returns but still received about 2% in gains. The loss, therefore, was minor compared to how much they might have lost in most any stock fund over the course of the last year.

Regardless of the limited amount of the loss, it has generated jitters among stable value fund investors. A few bloggers, like David Merkel of the Aleph Blog, suggest that this might be the "first crack in the foundation" and recommend that investors may want to consider switching to Treasury bond funds if those choices are available in their 401k. Merkel adds, however, that his purpose is not to scare investors out of stable value funds.

I came across an interesting item today that in a way supports stable value funds. In a press release from writer Barry J Dyke, he contends that 69.7% of funds in the $4.5 billion 401(k) Thrift Plan for the 22,000 Employees of the Federal Reserve System is invested in its Fixed Income Fund. This fund is exclusively invested in stable-value group annuity contracts from major U.S. life insurance companies. The fund has returned 5.8% while major stock averages have lost roughly 30%.

So if stable value is good enough for the Fed, is it good enough for the rest of us? I think it is indeed good enough but if you are looking for ultimate safety it won't hurt to allocate some of your 401k funds into Treasuries as well. I know I have.