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Safe Becomes New Slogan for Sorry Investors

"Stability" and "protection" have become the new investment buzzwords, replacing "wireless," "Web" and "high-tech" - words that wrought so much magic a mere three years ago.

Stable-value and principal-protection funds are two fund categories that have garnered tremendous assets over the past three years because of their decent returns - returns that during the bull run would have seemed pathetic but that investors and advisers are now avidly cleaving to since nearly every fund category is down.

Assets in principal-protection funds, which delivered a respectable 3.7% return last year, have skyrocketed since the beginning of the bear market, from $278 million to just under $3.8 billion, according to Lipper of New York. Stable-value funds, by far the bigger category, have increased 52% since the beginning of the bear, from $210 billion to $320 billion according to the Stable Value Investment Association. Over the past 20 years, stable-value funds have returned between 5.6% and 11.9%, according to Hueler Cos.

This stability and safety is what is driving all this sudden interest, said Kristen Adamonis, an analyst with Financial Research Corp. in Boston.

Principal Protection vs. Stable Value

Insurance wrappers are the lynchpin of both principal-protection and stable-value funds, although stable-value funds offer more flexibility since they do not lock up an investor's money for years. They also invest in high-grade fixed income, asset-backed and mortgage-backed securities, with a strategy designed to minimize volatility and maintain a stable net asset value, while principal-protection funds invest in bonds and/or equities.

Available only during an offering period, principal-protection funds promise to return an investor's principal, minus costs, at the end of a five to seven-year guarantee period. Up-front loads on these funds, about a third of which is for the insurance wrapper, can cost as much as 5.75%. Investors may exchange money in a principal-protection fund with other funds in the same family, but will suffer penalties for early withdrawal.

Stable value investments, until recently only offered through 401(k)s but now available to IRA investors through mutual funds, are designed to preserve the value of the principal and all accumulated interest. Defined contribution plans increasingly are offering stable value choices, according to Hewitt Associates, with two-thirds offering stable value.

The Gartmore Morley Capital Accumulation fund, one of the biggest stable value funds and the flagship of Gartmore Morley Financial of Lake Oswego, Ore., has returned 5.08% in the three years ended December 2002, net of fees, , according to the firm. Last year, it returned 2.83% above the Lipper Money Market Index. Its assets have ballooned from $50 million at the beginning of 2002 to just under $400 million, while the firm's overall assets surged from $8.2 billion at the beginning of 2002 $11.5 billion as of March 31, noted Jill Cuniff, managing director and chief investment officer of the firm.

While most institutional investors have used stable value in defined contribution plans for years, brokers and registered investment advisers recently have been introducing retail fund investors to stable value through IRAs, Cuniff said.

The Scudder PreservationPlus fund, another leading stable-value fund, from Deutsche Asset Management that recently crossed the $1 billion mark, was the first to be available in Individual Retirement Accounts. Interest in stable value is bound to remain high because of the continuing bear market and large number of Baby Boomers reaching retirement, said John Axtell, managing director and head of Deutsche's stable value unit.

Stable value returns of as much as 4% more than money market returns and state 529 plans' interest in offering more stability are also fueling flows, said Aruna Hobbs, director of pension and savings for Aegon Institutional Markets of Louisville, Ky. With more than $37 billion in assets in this category, Aegon is the biggest stable value manager in the nation.

Regulators' Warnings

While stable value and principal protection have attracted investors' and advisers' attention, they have also fallen under the radar of the National Association of Securities Dealers and the Securities and Exchange Commission. The NASD recently issued an investor warning against principal-protection funds' higher fees, potentially lower long-term capital gains and required long holding periods (see MFMN 3/28/03). The SEC, meanwhile, is looking into how stable-value funds arrive at their net asset values (see MFMN 3/27/03).

Bryan Portnoy, an analyst with Morningstar of Chicago, thinks the regulators may be onto something, as he maintains these funds are overpriced.

But Gabriel Altbach, vice president of product development at Pioneer Funds, counters that a product that can woo investors off the sidelines back into a mutual fund and give the investor a positive return, is doing both the industry and its customers a service.

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