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Stable Value Bond Funds Provide Smooth Sailing

NEW YORK ( TheStreet ) -- Most bond mutual funds sank in June. For the month, intermediate-term bond mutual funds lost 2.1%, according to Morningstar.

Rising interest rates caused the red ink. When rates climb, bonds tend to decline.

But millions of fixed-income investors in 401(k) plans avoided the pain by holding stable value funds. These funds reported steady gains throughout the downturn. Although they are backed by bonds, stable value funds are resilient because of insurance contracts that protect principal.

Stable value funds hold more than $700 billion in assets, accounting for about 20% of all the assets in 401(k) plans. The funds aim to protect principal while outdoing money markets and roughly matching the returns of mutual funds that hold mixes of short and intermediate-term bonds.

During the 15 years ending in June, the Hueler Stable Value Pooled Fund index returned 4.5% annually, compared to 2.4% for money markets. The stable funds have proved particularly attractive because they are much less volatile than competing mutual funds.

"Stable value funds enable you to capture the performance of a bond portfolio and be protected on the downside," says Aruna Hobbs, managing director of New York Life, which manages $22 billion of stable value funds.

As yields on money markets have nearly vanished recently, stable funds have continued delivering decent results. While money markets have returned 0.09% annually during the past three years, stable funds have returned 2.50%. The funds currently yield about 2.0%.

Because the stable value funds are so reliable, many 401(k) savers think of them as bank certificates of deposit. But stable value funds are not guaranteed by Federal Deposit Insurance Corp. insurance. Some of the funds are offered by insurance companies. Such funds are backed by the general portfolios of insurance companies. Most stable value funds invest in portfolios of bonds. To guard principal, the fund managers purchase protection -- known as wrap coverage -- from insurance companies.

The insurance does present default risk. But so far, stable value funds have navigated up and down markets, surviving the turmoil of 2008. "The risk controls have worked, and stable value funds have never had a negative year," says Karl Tourville, managing partner of Galliard Capital Management, which manages $84 billion of stable value assets.

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