If you are a typical 401(k) participant, you have stuffed 32% of your retirement money in a stable value fund offered by your company’s retirement plan. Throughout this crisis, stable value funds have lived up to their billing as “money market funds with better yields” or “intermediate bond funds sans the volatility.”

But do you know what a stable value fund is? Not according to a recent survey. Close to 90% of retirement plan sponsors (employers) don’t know the difference between a stable value fund and a regular bond fund, let alone plan participants (employees).

A stable value fund is a pool of fixed-income investments with an insurance contract on top to guarantee returns over a short period of time. It is an insurance product, not a money market or mutual fund. As such, the disclosure requirements mandated by the Securities and Exchange Commission (SEC) for mutual funds are not applicable to stable value funds.

For instance, a stable value fund is not required to report the market value or makeup of its underlying assets (they could be all toxic debts) or the fees it charges. All it needs to report is its book value (no wonder it does not fluctuate). There could be significant discrepancy between the book value and the underlying market value.

The benefits of a stable value fund

Even when the fund’s market value is lower than its book value, an individual plan participant (employee) is allowed to withdraw money at book value. In effect, existing participants are subsidizing those who take money out.

The perils of a stable value fund

The stable value fund works as long as withdrawals are few and far between. When there are systematic withdrawals, the fund has to make payments based on market value since the façade of book value can not be maintained.

As a matter of fact, the return insurance wrapper would be voided if any of the following events happen:

• Terminating the plan;
• Replacing an underperforming stable value fund;
• Adding a money market or bond fund to the retirement plan lineup;
• Communicating any material information to participants that may result in redemptions.

In other words, for the façade of stability, plan sponsors put themselves into a straight jacket that prevents them from discharging their fiduciary duty properly. If that isn’t a lawsuit waiting to happen, what is?

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