Wealth Management
Until a couple of decades ago, investors had few options when it came to asset classes. Since then, there has been an increase in the number of investable asset classes including REITs, commodities, currencies, etc. Yet so many of these have failed to provide sufficient diversification, especially during down markets.
Investors should consider fixed annuities as they offer capital protection guaranteed returns, and income regardless of market conditions. Thus, they are a way to generate income during retirement and also increase the resilience of portfolios.
Unlike fixed income, fixed annuities do not fluctuate in value depending on interest rates or other factors. Fixed annuities always have a positive, guaranteed return. When evaluating their portfolios, investors should consider market risk, credit risk, longevity risk, and liquidity risk.
A fixed annuity reduces a portfolio’s market risk due to there being a guaranteed return and no risk of loss of principal. It also leads to lower credit risk given that annuity providers have superior credit ratings. Longevity risk is also reduced given that annuities provide payments for life. There is a tradeoff in terms of liquidity risk as money invested in an annuity is not easily accessible.
Finsum: Fixed annuities can lead to more resilient portfolios. Although there is a tradeoff in terms of liquidity, it can reduce a portfolios’ market, credit, and longevity risks.
There was strength across the board in fixed income following an inflation report that continued last month’s cooling trend and a dovish FOMC meeting. The yield on the 10-Y was 27 basis points lower, while the yield on the 2-Y dropped by 36 basis points.
The November CPI report showed a monthly gain of 0.1% for the headline figure which was in-line with expectations and a slight increase from last month’s unchanged print. Core CPI came in at 3.1% on an annual basis which was consistent with expectations. Overall, the report indicates that inflation continues to moderate and is getting closer to the Fed’s desired levels.
While fixed income rallied following the CPI, the rally accelerated following the dovish FOMC meeting and press conference. The Fed held rates steady but surprised markets as it now expects 3 rate cuts in 2024. It also downgraded its 2024 inflation forecast to 2.4% from 2.6%.
In his press conference, Chair Powell affirmed progress on inflation and noted that the economy was slowing in recent months especially from Q3’s rapid pace. He added that high rates were negatively impacting business investment and the housing market. Markets jumped on his remark that further rate hikes were ‘not likely’ although possible if necessary.
Finsum: Treasury yields were sharply lower following a soft CPI report and dovish FOMC meeting. Stocks and bonds were bought higher as the Fed is now forecasting 3 rate cuts in 2024.
A sizzling rally in stocks and bonds is leading investors to scoop up ETFs. In November, the iShares 20+ Yr. Treasury Bond ETF (TLT) was up 9.9%, while the Morningstar Global Markets Index, a gauge for global equities, was up 9.2%.
The major driver of the rally is increased optimism about interest rates given positive news regarding inflation while the economy continues to avoid a recession. This means the biggest gains were found in interest-rate sensitive sectors which have been among the most battered since the Fed embarked on tightening policy early in 2022.
There were also $110 billion inflows into US ETFs with $77 billion going into equities and $31 billion into fixed income ETFs. This was a 1.6% increase from last month and total ETF flows should easily exceed $500 billion, setting a new record. Fixed income ETFs saw a 2.2% growth rate on a monthly basis and inflows are up 14.3% compared to last year, exceeding equities’ growth rate of 5.6%.
Active ETFs continue to grow and account for $21 billion of inflows. YTD, total inflows are $116 billion which exceeds $90 billion in 2022. Some areas of growth in the segment are alternative assets and inverse funds.
Finsum: 2023 is set to be a record year in terms of ETF inflows. Fixed income ETFs and active funds are two of the biggest areas of growth.
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High yield bond ETFs are seeing a surge of inflows as risk appetites reignite. In November, US-listed high yield bond ETFs had $10.8 billion of inflows which surpassed the previous record of $8.6 billion in April of 2020. The inflows in November were enough to offset the $8.7 billion of outflows in the previous 3 months. Globally, there was $127.5 billion of inflows into ETFs which was the highest amount since December 2021.
There was strength across certain parts of the fixed income complex as investment grade corporate bond ETFs saw $10 billion inflows which is the most since January. In contrast, Treasuries saw their lowest levels of inflows since January 2022. There was a sharp decline from the $30.4 billion inflows in October to just $4.3 billion in November, a reflection of the U-turn in sentiment.
According to Karim Chedid, head of investment strategy for BlackRock’s iShares arm in the Emea region, “Investors have cash to put to work, and if the assessment of the investment environment is better than expected, that dry powder can be put to work.” Another factor is that retail investors have many more low-cost options when it comes to high yield ETFs which seem like an ideal vehicle to take advantage of a ‘soft landing’ scenario which should be bullish for the asset class.
Finsum: High yield ETFs saw a surge of inflows in November. Here are some of the reasons why the category should benefit from a soft landing.
Direct indexing has been around for 30 years but was once only accessible and viable for ultra-high net-worth investors. Now, technology and lower transaction costs have made it available for a much wider swath of investors who are able to benefit from direct indexing’s tax-loss harvesting and customization abilities.
Interestingly, the strategy is finding particular favor among millennial investors who are interested in tax optimization and personalization which are not possible through traditional passive investing. Advisors can customize holdings in a way that reflects a client’s values and preferences such as prioritizing ESG criteria or adjusting a portfolio based on a client’s risk profile. Holdings can also be customized to account for a clients’ unique financial situation, which is also not possible through investing in ETFs or mutual funds.
For advisors, it presents an opportunity to differentiate themselves in a competitive landscape by offering personalized and optimized solutions. Direct indexing is likely to continue growing as it’s becoming increasingly available through many online brokerages and wealth management firms. It’s also consistent with many younger investors’ desired preference to have their personal holdings reflect their values and beliefs.
Finsum: Direct indexing is growing at a rapid pace, and it’s finding favor with Millennial investors due to its tax optimization and personalization.
JPMorgan issued its 28th annual Long-Term Capital Markets Assumptions report, which provides long-term forecasts for various asset classes in addition to detailing risks and upside catalysts. One of the recommendations in its report is to add a 25% position to alternative investments which it believes will increase returns by 60 basis points on an annual basis while also reducing volatility.
In terms of the 60/40 portfolio, JPMorgan is forecasting annual returns of 7% which is a slight decrease from last year’s forecast of 7.2% annual returns. Pulkit Sharma, JPMorgan’s head of real assets and alternative investment strategy, remarked, “The alternative asset classes are becoming more essential than optional in the broader 60/40 toolkit. Inflation is going to be more and more sticky, so you need more diversifiers and inflation-sensitive asset classes.”
The bank also believes that investors need to seek out diversification especially, since it expects continued geopolitical uncertainty and volatility stemming from central bank decisions. Fixed income is simply not an effective diversifier in higher-inflation environments as evidenced by the last couple of years. Some of the alternative assets it recommends boosting diversification are real assets, hedge funds, and private credit.
Finsum: In its annual long-term review and forecast of various asset classes, JPMorgan slightly reduced its expectation of long-term returns for a 60/40 portfolio and stressed the role of alternatives to boost returns and improve diversification.