Only recently available to individual investors, stable value funds boom.

Even though I consider myself a capable investor, I use a financial advisor to handle the aggressive part of my portfolio. Quite honestly, I just don't have the nerve to tackle that responsibility myself.

So I thought it was somewhat curious when, late last year, a statement came in the mail showing that he had invested in a dowdy sounding fixed-income vehicle called the PBHG IRA Capital Preservation Fund. When I questioned him about it, he explained that this was a stable value fund. Its net asset value would always remain a constant $10 a share, regardless of what happens to interest rates. And it was yielding around 4.5%, which sounded rich since money market fund yields were drowning below the 1% mark, and the stock market still resembled a bottomless pit. It sounded so good, in fact, that I decided to put some money from an IRA account that I managed myself into the fund.

Earlier this year, my advisor contacted me again to get permission to take the money out of the stable value fund and put it to work in the stock market, which he believed was finally showing signs of sustainable life. Trusting his advice, I OK'd the move. But because I had held the shares for less than a year, I learned that I would be charged a 2% exit fee. I continued to hang on to the shares in my own IRA, though, and today am perfectly happy to be earning what I consider a fairly secure and riskless bond-like return without having to worry about the principal fluctuation of a bond fund, especially when interest rates look poised to go up.

My experience, in a nutshell, summarizes both the good and unfavorable attributes of stable value funds. At a time when money market funds are still yielding less than 1%, losing money to inflation by parking cash there just doesn't make sense. At the same time, the threat of rising interest rates makes even short-term bond funds look a little sinister.

To a growing number of investors, stable value funds represent a safer alternative to a traditional bond fund because they are designed to keep a constant net asset value. The device that allows them to make that pledge is an insurance agreement called a "wrapper," which gives the fund money to redeem shares at a constant price even if rising interest rates have eroded the value of bonds in the portfolio. Their current yields, while they change daily like any other bond fund, resemble what you'd get from a portfolio of short- to intermediate-term bonds.

While stable value funds have long been a staple of 401(k) plans, they have only recently been made available to individual investors and financial advisors. To avoid heavy redemptions, fund companies only offer stable value funds for retirement accounts such as IRAs, and in some states, through 529 education savings plans.

According to the Stable Value Investment Association, a Washington, D.C., trade group, investors have about $6 billion invested in the new breed of stable value funds available directly to the public. "We have seen the amount of stable value funds in IRAs double each of the last two years," says Gina Mitchell, president of the association. "There is a pent-up demand, particularly from those who don't have access to stable value investments through a 401(k)."

But that safety and higher yield comes with a price. In order to stabilize their asset base and discourage market timers, the funds typically impose an early withdrawal fee. Some funds, such as PBHG's offering, impose it if investors sell their shares before a specified period of time. Others, such as the Scudder PreservationPlus Income Fund, levy the fee if interest rates rise beyond a certain level.

The exit fee has not deterred financial advisors from taking the plunge. "I use them extensively as a substitute for bond funds, especially in a rising interest rate environment," says Lou Stanasolovich, president of Legend Financial Advisors in Pittsburgh. "They've been a solid addition, and I haven't been disappointed."

"The most obvious attraction is that these funds have current yields that are about double what you can get from a short-term bond fund," says Edward Stuart, an advisor with RegentAtlantic Capital, LLC, in Chatham, N.J. "I use them for about 5% to 10% of my fixed-income allocations." Although the traditional bond funds Stuart invests in have performed better than stable value funds over the last three years because of a falling interest rate environment, he believes the latter investment will take the lead when rates rise.

That was certainly the case in 1999. When interest rates ticked up that year, the average government intermediate-term bond fund fell 1.7%, and the Lehman Brothers Corporate Bond Index dropped by 1.9%, according to Lipper. By contrast, Scudder PreservationPlus Income ended the year with a 5.99% return.

Despite their resilience in a bearish bond market a few features of stable value funds, as well as an uncertain regulatory environment, bear watching. While they would probably hold up better than traditional bond funds in a rising rate environment, their redemption fees mean that investors would not necessarily escape totally unscathed.

To help head off the potential for massive shareholder redemptions if rates vault rapidly, Scudder reserves the right to impose a 2% contingent redemption charge if investors cash out when the rate of the Lehman Brothers one-to-ten-year Treasury Index exceeds the yield of the fund portfolio by more than 155 basis points. While that has not happened since the fund was established in 1999, it is not an unthinkable scenario. And since there is no time limit on the fee, it would apply whether you've held the fund for six months or six years. Another interest-rate-related-risk for stable value funds includes the possibility of a spike in money market rates, which would make yields on the short- and intermediate-term securities the funds invest in less attractive by comparison.

Mitchell believes that neither development would spark a massive exit by shareholders. "Investors like stable value funds because they offer steady, positive returns minus the volatility of a bond fund," she says. "They are also a powerful diversifier, and people don't want to abandon that."

Aside from changes in interest rates, other factors could impact yields. Stable value funds are more expensive to run than traditional bond funds, and several fund companies waive a portion of their costs to keep their expense ratios at 1%. Discontinuing that policy would trim yield by about 30 to 50 basis points, according to the latest prospectuses from PBHG and Scudder. Credit mishaps could also impact fund yield because the insurance wrapper only pledges to maintain a steady net asset value and does not guarantee against losses from credit-related issues.

Finally, it's probably a good idea to keep an eye on the SEC's investigation into how stable value fits into its accounting framework for mutual funds, and how the insurance company wrapper agreements work. According to Mitchell, about ten to 15 funds are "in limbo" because of the investigation, which first came to light in a Wall Street Journal article earlier this year. The Stable Value Investment Association's website offers a mildly encouraging, yet inconclusive, take on the matter. "Although no one knows what the SEC will decide," notes the site, "if the SEC decides that the accounting should be different, making it difficult for mutual funds to continue to hold a stable share value, some stable value managers have indicated it is unlikely that the shares of their funds will experience an immediate significant drop in value in today's low interest rate environment." An SEC spokesman declined to comment on the issue.

Stable Value Funds Available To Financial Advisors

Scudder Preservation Plus Income Fund from Deutsche Preservation

Plus Income Fund, (800) 621-1048

Gartmore Morley Capital Preservation Fund, (800) 485-2294

PBHG IRA Capital Preservation Fund, (800) PBHG-NOW

Principal Investors Capital Preservation Fund, (800) 247-8000 ext. 498

Oppenheimer Capital Preservation, (800) CALL-OPP

Vantagepoint Income Preservation Fund, (800) 669-7400

Source: Stable Value Investment Association