Treasury yields jumped higher following the hotter than expected March CPI report. The 10-year Treasury yield moved above 4.5%. It has now retraced more than 50% of its decline from its previous high in late October above 5%, which took it to a low of 3.8% in late December, when dovish hopes of aggressive rate cuts by the Fed peaked.
Clearly, recent labor market and inflation data have not been consistent with this narrative. In March, prices rose by 3.5% annually and 0.4% monthly, above expectations of a 3.4% annual increase and 0.3% monthly gain. Core CPI also came in above expectations.
Instead of trending lower, inflation is accelerating. Now, some believe that the Fed may not be able to cut rates given the stickiness of inflation. Additionally, economic data remains robust, which also means the Fed can be patient before it actually starts lowering the policy rate.
Some of the major contributors to the inflation report were shelter and energy costs. Both were up 0.4% and 2.2% on a monthly basis and 5.7% and 2.7% on an annual basis. Shelter, in particular, is interesting because its expected deceleration was central to the thesis that falling inflation falling would compel the Fed to cut.
Finsum: The March CPI came in stronger than expected, leading to an increase in Treasury yields. As a result, we are seeing increasing chatter that the Fed may not cut at all.
Following the better than expected March jobs report showing a gain of 303,000 jobs, Treasury yields moved higher across the curve. The 10-year yield initially rose 14 basis points to a new 2024 high of 4.43% before backing off a bit. Overall, the jobs report reduces the urgency of the Federal Reserve to cut rates given the labor market’s resilience.
Going into the report, consensus expectations were for an increase of 200,000 jobs, which would be a softening from the 270,000 jobs added in February. It adds to the data showing inflation moving sideways rather than lower over the past couple of months.
Yields also rose on Thursday following comments from Neel Kashkari, President of the Federal Reserve Bank of Minneapolis, questioning the likelihood of rate cuts if inflation continues to linger above 2%. As a result, the odds of the Fed not cutting rates at the May and June meetings have increased.
Some other positives from the report were the unemployment rate declining to 3.8%, despite an increase in the labor force participation rate to 62.7%. Average hourly wages increased by 0.3% on a monthly basis and by 4.1% annually. Both figures were in line with expectations. Job gains were strong across the board, with the biggest contributors being healthcare, government, leisure and hospitality, and construction.
Finsum: Treasury yields moved higher following a stronger than expected March jobs report. Overall, the report led to a decrease in the odds of a rate cut at upcoming Fed meetings.
Investors with over $250,000 are increasingly turning to separately managed accounts, allowing them to handpick municipal bonds with professional guidance. These accounts now hold $987 billion in assets, surpassing mutual funds, which hold about $769.7 billion.
This shift has significantly boosted business, with Franklin Templeton seeing a 50% increase in assets under management over the past year and a half. Lowering the minimum investment to $250,000 has made these accounts more accessible, though still beyond the reach of most Americans.
However, advancements in technology are driving further accessibility, with potential for minimums to drop to $100,000 in the near future. With artificial intelligence breaking down barriers by making management for portfolio quicker to digest the minimums are bound to fall.
Finsum: The SMA explosion is here to stay in the fixed income market and managers should watch the evolution.
Over the last year, there has been an increase in the accessibility and availability of direct indexing solutions. Still, the category continues to be dominated by high net worth or ultra high net worth investors. According to Anton Honikman, the CEO of MyVest, there is about $400 billion managed by direct indexing strategies. He anticipates that the next stage of growth for direct indexing will depend on younger and less affluent investors.
Initially, the primary advantage of direct indexing was that it allowed investors to extract tax alpha. He forecasts that as direct indexing becomes democratized over the next few years, providers and advisors will have to make some adjustments.
He notes that custodians will have to offer fractional share support for the technology to work for smaller investors, as implemented by Schwab and Fidelity, which now offer direct indexing to investors with lower minimums.
Typically, there is some premium involved with direct indexing over investing in low-cost ETFs. Given the increase in ETF options over the last couple of years, he believes that it marginally erodes the use case of direct indexing for many investors. Over the longer term, he sees the direct indexing premium compressing in order to remain viable vs. a portfolio of low-cost, targeted ETFs. Further, he believes that the next wave of direct indexing will be driven by younger investors who want to align their portfolios with their values rather than optimize their tax situation.
Finsum: At one time, direct indexing was only available to high or ultra high net worth investors. As it becomes democratized, here are some considerations for providers and advisors.
Unlike mutual funds or ETFs, personalized indexing permits harvesting losses at the security level, offering more opportunities for ultra-high-net-worth investors to capture additional tax advantages. Tax-loss harvesting involves selling an investment at a loss and reinvesting the proceeds into another asset, a key benefit of direct indexing.
Direct indexing strategies involve selling stocks below their cost basis and instantly repurchasing correlated replacements to avoid wash-sale rule violations. Since investors own individual stocks in their portfolios, losses can be captured even when the index gains value. DI experts exemplifies this strategy by selling underperforming securities during market gains, using harvested losses to offset capital gains and taxable income up to $3,000 annually, with the option to carry over losses to future years.
Maximizing tax alpha depends on the frequency of portfolio scans for harvesting opportunities, with daily scanning potentially improving after-tax returns by 1% to 2% or more. Commitment to direct indexing underscores its importance in tax-efficient investing.
Finsum: The frequency through which a portfolio can be scanned for tax-loss harvesting is making the case extremely compelling for direct indexing.
Broadridge Financial Solutions, a financial technology infrastructure provider, expects total assets in model portfolios to exceed $11 trillion by the end of 2028. This would represent more than a doubling of assets over the next 5 years from $5.1 trillion at the end of last year. This forecast is slightly more optimistic than Blackrock’s prediction that model portfolio assets will reach $10 trillion over the next 5 years.
Model portfolios are increasingly being utilized by financial advisors as the industry shifts to a greater focus on planning and client service vs. investment management. In addition to freeing up valuable time and resources for advisors, research has also shown that they tend to outperform, especially during volatile markets, and lead to greater client satisfaction.
For asset managers, model portfolios are a source of growth for ETFs. Currently, 63% of model portfolio assets are in equities, with 32% in fixed income. ETFs comprised 51% of assets in model portfolios, compared to 26% for mutual funds. According to Andrew Guillette, Broadridge’s VP of Global Insights, “We expect ETFs to continue to take share from mutual funds inside model portfolios, driven primarily by their attributes as low-cost and tax-efficient portfolio-building blocks.”
Finsum: Broadridge Financial is forecasting that model portfolio assets will more than double over the next 5 years. It’s expected to drive growth for various asset managers’ ETFs and help advisors focus on client service and building their practices.
It’s an opportune time for younger financial advisors. Many older advisors are nearing retirement, and we are on the precipice of a generational wealth transfer from baby boomers to millennials. However, this doesn’t negate the significant challenges and obstacles faced by new advisors, given their high failure rates. Here are three tips from established advisors to increase the odds of success.
According to Timothy Smith, the founder and CEO of Aurora Private Wealth, rookie advisors need to get used to rejection. He believes that advisors need to develop intangible qualities like perseverance, determination, and discipline in order to successfully build a practice. Further, advisors should have a genuine desire to help people feel in control of their financial lives.
Tammy Haygood, a private wealth advisor at RBC, is an advocate for not using jargon and believes that advisors should be able to explain concepts in clear and simple language. This can only be achieved by having a comprehensive understanding of the material and concepts. She also insists that authenticity is key in order to build trust and form long-term relationships with clients.
Nate Lenz, the co-founder and CEO of Concurrent, believes that younger advisors should seek out mentors. He sees financial advice as an ‘apprenticeship’ business. With the right mentor, advisors can quickly become competent and knowledgeable in multiple areas, such as planning, investments, closing deals, and client service. In this vein, he strongly believes that younger advisors should prioritize experience over other factors like compensation.
Finsum: There’s a lot of difficulty and struggle for advisors at the beginning of their careers. Here are some tips from established, successful advisors on how rookie advisors can maximize their chances of success.
Morgan Stanley expanded its ETF lineup with the introduction of the Eaton Vance Total Return Bond ETF (EVTR) and the Eaton Vance Short Duration Municipal Income ETF (EVSM). The bank is joining many of its peers in converting fixed income mutual funds into active fixed income ETFs.
EVTR focuses on seeking total return through diversified investments in fixed-income securities, including corporate, municipal, U.S. government, and asset-backed securities. EVTR is actively managed and has an expense ratio of 0.32%. Its holdings have an average duration of 6.5 years and an average yield of 4.4%.
EVSM aims to provide investors with tax-exempt current income by predominantly investing in municipal securities with a short-term focus. The fund has a net expense ratio of 0.19%. The average duration of its holdings is 1.75 years, with an average yield of 4.7%.
Both funds were originally highly ranked mutual funds, with EVTR's predecessor, MSIFT Core Plus Fixed Income Portfolio, achieving a ten-year track record in the top decile, and EVSM's precursor, the MSIFT Short Duration Municipal Income Portfolio, ranking in the top third of its category over five years.
With these additions, Morgan Stanley now offers 14 ETFs in the U.S. and has more than $1 billion in total assets, despite introducing its first ETF early last year. Like many other asset managers, Morgan Stanley is looking to capitalize on increased demand for ETFs and active fixed-income strategies.
Finsum: Morgan Stanley is joining many of its peers in converting mutual funds into active ETFs with the launch of the Eaton Vance Total Return Bond ETF and the Eaton Vance Short Duration Municipal Income ETF.
Nearly $68 trillion in assets are moving to a younger generations over the next 30 years, wealth management firms catering to high-net-worth individuals (HNWIs) are urged to adapt by integrating digital solutions to complement their bespoke services, rather than replacing them outright.
HNWIs, distinguished by their substantial asset portfolios, require a tailored approach from wealth managers, particularly given their demand for nuanced portfolio guidance across various asset classes, such as real estate and cryptocurrency. While digital tools are reshaping consumer expectations within financial services, HNWIs continue to prioritize the personal touch and customized service that comprehends their unique preferences and financial complexities.
However, there exists a gap in consistently delivering such personalized service, with over half of surveyed HNWIs reporting a lack of proactive support from their providers. Despite the surge in digital engagement during the pandemic, HNW clients still value personalized experiences, indicating a need for wealth managers to strike a balance between digital convenience and maintaining a human touch.
Finsum: Most clients want a mix of digital and personal service which advisors can use to leverage further business.
The last 40 years have been defined by lower inflation, creating a generous tailwind for fixed income. Now, AllianceBernstein believes that we are in the midst of a transition to a new regime that will feature lower growth and higher inflation. In this environment, the firm believes that fixed income investors need to make appropriate adjustments.
It believes that inflation will be structurally higher in the coming decades due to deglobalization and demographics. Deglobalization means that supply chains will be reshored, undoing some of the deflationary trends of the last 40 years, and it will result in higher inflation due to greater manufacturing costs and wages. With an aging population, there is a smaller pool of available workers, which will also contribute to inflationary pressures. Both deglobalization and demographic trends will weigh on economic growth as well.
Due to these factors, AllianceBernstein forecasts that 2% inflation is now the lower bound rather than a target. It believes that frequent spikes in inflation, as experienced from 2021 to 2022, will also become commonplace. This is a consequence of governments with large amounts of debt and future liabilities. Policymakers will be incentivized to ‘inflate’ away the debt rather than make painful cuts to spending. Additionally, lower rates will help contain financing costs.
Finsum: The last 40 years were great for fixed income due to inflation trending lower along with interest rates. AllianceBernstein believes this era is over, and we are moving into a new period defined by lower growth and higher inflation.
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In today's interest rate climate, holding a significant cash reserve is a prudent strategy. While long-term investors may benefit from stock investments, individuals requiring immediate access to funds or building emergency savings find value in holding cash. With high-yield savings accounts offering rates of 5% or more, real returns on cash savings are attractive. However, for those seeking to optimize returns while maintaining liquidity, there are two fixed income ETFs that offer advantages.
Two ETFs, iShares 0-3 Month Treasury Bond ETF (SGOV) and JPMorgan Ultra-Short Municipal Income ETF (JMST), offer different tax strategies to potentially enhance after-tax returns without significant additional risk.
Short-term Treasury bonds provide state tax exemption on interest earnings, making them appealing for residents of high-tax states, while municipal bonds offer federal tax exemption and may also be exempt from state and local taxes. Investors should assess the trade-offs between tax advantages and lower yields to determine the best fit for their financial situation.
Finsum; When accounting for tax advantages, fixed income ETFs could provide a more secure and efficient outlet for mitigating risk.
Investors grappling with market uncertainty are exploring ways to manage risk effectively while staying invested; utilizing buffer strategies, which employ options to provide targeted downside protection, offers a solution by mitigating losses during market downturns while limiting upside potential.
Accessing buffer strategies through ETFs simplifies the process, avoiding the complexities of managing options directly or the expense of structured notes. Buffer ETFs, managed by experienced professionals and offering intraday liquidity at a low expense ratio, present an accessible option for investors.
Designed for long-term strategic allocation, these ETFs can be utilized by investors looking to reduce equity drawdown risk, seeking moderate growth, or exploring outcome-oriented strategies within their portfolios, thereby providing a flexible approach to risk management in uncertain markets.
Finsum: Buffer strategies seem to make the most sense when there is overall upside but potential for volatility, similar to our current macro landscape.
Commonwealth Financial Network has forged a strategic alliance with Succession Link, a specialized fintech platform focusing on M&A and succession planning, to revolutionize practice management. Through the integration of Succession Link's bespoke solution, advisors can now seamlessly identify compatible continuity and succession partners.
The imperative for advisor succession planning is underscored by Cerulli Associates, forecasting the retirement of 100,000 advisors overseeing $10 trillion in client assets within the next decade.
Commonwealth's consolidated platform not only streamlines access to practices for sale but also furnishes advisors with valuation tools, fostering succession planning activity. Succession Link's suite of features, including compatibility scoring and advanced messaging functionalities, aligns with the overarching goal of empowering financial professionals to navigate succession challenges adeptly.
Finsum: Technology tools will be changing the game in advisor recruiting as demographic shifts begin to hit the industry.
Bonds and stocks were higher following the Federal Reserve’s decision to hold interest rates steady. The rally was a result of Fed Chair Powell reaffirming that rate cuts were still on track for later this year. He also added that the ‘policy rate is likely at its peak’.
The dot-plot also showed that FOMC members are forecasting 3 rate cuts by the end of the year, which is in line with the market’s consensus and a reduction from their previous forecast of 4 rate cuts. Committee members also upped their forecast for GDP growth to 2.1% from 1.4%, while modestly lowering their forecast for the unemployment rate to below 4%.
According to Fed futures, there is a 75% chance that the first rate cut will be at the June meeting. However, the larger message from Powell is that the Fed can afford to be patient given that the economy remains in a healthy place despite restrictive monetary conditions.
Another catalyst for equities and fixed income was Powell’s comments on the balance sheet runoff. So far, the Fed has reduced its balance sheet by about $1.4 trillion since June 2022 by letting proceeds from maturing Treasuries and mortgage-backed securities roll off the balance sheet instead of being reinvested. Powell indicated that this round of quantitative tightening was nearing an end and that discussions were ongoing about when it would be ‘appropriate to slow the pace of the runoff fairly soon’.
Finsum: Stocks and bonds were higher following the Fed’s decision to hold rates steady. Two particular catalysts were Chair Powell’s affirmation that the Fed’s next move would be to cut rates and comments about slowing the pace of quantitative tightening.