INSIGHTS
Currency
Insights
Stable Value
Funds:
The
Outlook foroption
the Japanese
The conservative
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Over the past decade or more, as the responsibilities of retirement savings have shifted from
employers to employees, there has been much
consternation and debate about participants’
abilities to do an adequate job investing for their
own retirements.
Helping retirement plan participants
invest wisely
In most cases, participants continue to save too
little and to invest poorly, often with too conservative of an investment stance. It is these circumstances, in part, that led to the recent regulatory law, H.R. 4, the Pension Protection Act
of 2006 (PPA). Some of the PPA’s main goals
were to get participants to start earlier, save
more, and invest more appropriately for the
long-term nature of retirement savings.
With this backdrop, much attention has been
paid to investment solutions such as balanced or
target date funds, which shift much of the decision making toward investment professionals,
and out of the hands of ill-equipped participants. This effort and subsequent shift is arguably a good thing and should go a long way
toward better preparing people financially for
future retirement.
Peter Chappelear
Senior Stable Value
Fund Manager
U.S. Fixed Income
But not all participants are created equal, even
those in the same retirement date bucket. Some
participants’ tolerance for risk, or stomach for
volatility, may appropriately be much less than
others. As such, their need for a very conservative investment option is quite real, and needs to
be provided for as best as possible.
Weighing conservative strategy options
Enter the three main conservative strategies available within DC plans: money market funds, bond
funds, and stable value funds. What follows is a
discussion of these various strategies, with the
conclusion that stable value is the best option of
the three for participants saving for retirement in
DC plans.
What is it about a conservative investment option
that is valued most by participants? Certainly
some sophisticated participants seek a counterbalance to equities, particularly when equity prices are
falling. For those people, a bond fund, which tends
to appreciate most when equities are hurting and
interest rates are falling, is probably best.
But for most participants, what they are really
looking for is a safe haven from the volatility
associated with general market swings. Most
participants don’t understand or realize that
bond funds can go down in value, which is not
what they want for their “safe” assets. The principal preservation characteristic of money market funds — investor balances don’t go down
— provides the peace of mind that participants
are looking for. The problem is that the anemic
returns seen historically aren’t going to provide
enough income for retirement.
Money market vehicles are intended primarily
for overnight liquidity.
The reason that money market returns have
been low is because they were never designed to
be a savings vehicle — especially not for longterm goals like retirement. In order to be able to
maintain investor balances day-to-day, the
money market funds must invest according to
Rule 2a7 — in ultrashort, highly-rated instruments with a maximum weighted average
maturity of 90 days.
Stable value funds, like money market funds, are
designed to provide investors with principal preservation
in all market conditions. But the investments backing a
stable value fund tend to be more broadly diversified,
and of a longer nature than money market funds, more
like an intermediate term bond fund. Typically, stable
value funds have an average duration of 2.5–3.5 years,
although individual investments may be longer.
The wrap contracts act as both shock absorbers and as a
safety net. The result is that a stable value fund feels
much like a money market fund — investors won’t lose
money — but can be invested to produce better longterm returns. And over the long-term, stable value
funds have done just that: providing higher returns with
equal or better principal protection.
market yields.
A recent study by David Babbel,1 professor of insurance
and finance at the University of Pennsylvania, indicates
that since 1988 stable value funds have outperformed
money market funds by more than 200 basis points at
a similar level of risk.
Stable value’s “wrappers” are the source of
its unique risk/return profile
The comparison in Exhibit 1 demonstrates the dramatic relationship between stable value and money
market returns historically.
As the FED lowers short-term rates, we can expect
a wider gap between stable value and money
What makes stable value different than a bond fund is
a special kind of protective investment called a wrap
contract. The wrap contracts, which are issued by highquality banks and insurance companies, insulate the
fund from price gyrations and protect the value of the
fund from any price declines on a daily basis.
Bonds posted strong positive returns in 2007
(Lehman Aggregate Index – 6.97%), but may be
poised to reverse that strong performance when
intermediate interest rates rise.
Exhibit 1: Historic return comparison
20%
18%
16%
14%
12%
Stable Value
10%
8%
6%
4%
2%
0%
1977
Money Market
1982
1987
1992
1997
2002
2007
Source: Lehman Brothers, JPMorgan Asset Management
Money Market returns are indicated by annualized 3-month T-Bill returns. Stable value returns reflect Lehman Intermediate Aggregate index
market value returns converted to a stable value return series starting 1/1/77 using a typical compound crediting rate formula within benefit
responsive contracts issued by banks and insurance companies. Returns are net of 8 bps benefit responsive fees and do not include investment
management fees. Returns do not reflect the effect of cash flows. A different start date would produce different results.
1
“A Closer Look at Stable Value Funds” — http://fic.wharton.upenn.edu/fic/papers/07/0721.pdf
2
Low volatility is one of the key strengths of a stable
value fund, and adds to its appeal as a long-term savings
vehicle for retirement portfolios.
roughly the past 20 years. Over a long-term investment
horizon appropriate to most retirement plan participants, Stable Value is clearly a more effective way to
reduce volatility while enhancing returns.
Stable Value funds, with their long-term horizon and
principal protection features, offer investors a way to
sidestep daily market volatility and remain fully invested throughout every part of a market cycle.
By combining the best attributes of both money market
funds and bond funds, namely principal preservation
and enhanced returns, Stable Value offers participants a
rare opportunity to have their cake, and eat it too.
Stable value: a safe port in stormy markets
Exhibit 2 compares the long-term steady rate of return
for stable value against the volatility of other funds, over
Exhibit 2: Bonds in comparison: monthly returns are volatile
Bond Fund
Money Market Fund
Stable Value Fund
3.0%
2.5%
Monthly return
2.0%
1.5%
1.0%
0.5%
0.0%
-0.5%
-1.0%
-1.5%
-2.0%
1990
1993
1996
1999
2002
Source: Lehman Brothers, JPMorgan Fleming Asset Management
Stable Value Fund is represented by 2% cash, 98% wrapped Lehman Aggregate Intermediate Index with returns that are net of 0.08% wrap fees.
Stable Value returns do not reflect the effect of interim cash flows. A different start date would produce different results. Money Market Fund is
represented by 3-month Treasury bill yields. The Bond Fund returns are represented by the Lehman Aggregate Index.
3
Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends,
which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or
completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. References to specific
securities, asset classes, and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as,
recommendations.
These materials have been provided to you for information purposes only and may not be relied upon by you in evaluating the merits of investing
in any securities referred to herein. Past performance is not indicative of future results. Indices do not include fees or operating expenses and are
not available for actual investment. Indices presented, if any, are representative of various broad base asset classes. They are unmanaged and
shown for illustrative purposes only. The views and strategies described may not be suitable for all investors. This material has been prepared for
informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. You should consult
your tax or legal advisor regarding such matters.
JPMorgan Asset Management is the marketing name for the asset management businesses of JPMorgan Chase & Co. and its affiliates worldwide
which includes but is not limited to J.P. Morgan Investment Management Inc., JPMorgan Investment Advisors, Inc., Security Capital Research &
Management Incorporated, J.P. Morgan Alternative Asset Management, Inc.
www.jpmorgan.com/insight
© JPMorgan Chase & Co., 2008
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