In an effort to steer market-weary customers into their pockets, firms are offering principal protection on a number of funds, and some investors have warmed up to the old adage, "A bird in the hand is worth two in the bush."

These guaranteed mutual funds insure the money investors put in during a down market - but return limited upside when the market rises and typically lock investors in for five to 10 years.

"You give up profit so that you are protected against the downside," said Don Cassidy, senior analyst with Lipper of New York. In addition, these funds retain "assets more reliably than bond funds, which at some point will start declining," Cassidy said, referring to the anticipated increase in the Federal Reserve interest rate, which inevitably will push fixed-income returns down.

Total net assets in these safe-harbor funds more than doubled from $4 billion at the end of last year to nearly $8 billion at the end of July, according to Lipper. And the growth of principal-protection funds since the beginning of this bear market has been astronomical, considering they had less than $250 million at the end of 1999.

Principal-protection funds have returned 13.2% so far this year, compared to -19.6% for the average equity fund, according to Lipper.

American Century of Kansas City, Mo.'s principal-protection fund, an inflation-adjusted bond fund, has nearly tripled in assets this past year from $122 million to $341 million, even though the fund has been around since 1997, said Deborah Larson, a spokeswoman for the firm.

While the company has not increased its principal-protection offerings, Larson said the recent success in the fund will most likely prompt the firm to explore other distribution channels.

Larson outlined some of the main reasons for the shift toward these types of funds, the first being "conservative investors" looking for "inflation-protected securities." Another is an increased demand among investors looking for alternatives to the stock market. Cassidy agreed that principal protection gets otherwise reticent investors to buy into an equity-type product.

"With problems in the economy and recent scandals, investors are saying, Give me quality,'" Cassidy said.

"These things are offering a little bit better yield than short-term intermediate funds," he said.

Investors' uncertainty is even causing some fund companies to offer principal-protection in 401(k)s, for Baby Boomers worrying that their retirement savings could evaporate, and in 529s, for parents fretting over college funds for their kids. In fact, 29% of the parents and grandparents saving for college are very concerned that they will not have enough for their children's college education, a recent survey by Alliance Capital of New York showed [see MFMN 9/9/02].

Recently, MetLife of New York included a principal-protection option in its North Carolina 529 college savings plan [see "News Flash," page 5]. MetLife has also introduced a stable-value IRA mutual fund for 401(k)s, which has nearly doubled to $2.44 billion in the past year.

As a category, stable-value funds in 401(k) plans have grown by 9% over the past year, taking in $15 billion in new retirement savings, according to Lipper.

"I think we'll continue to see growth of these funds because a lot of people are still scared of stocks, and this is one kind of fund people will flock to in this type of economy," Cassidy said.

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