Wealth Management
Since the yield on the 10-year inched above 5% in October, we have seen a relentless rally in Treasuries. According to Bank of America, this rally is due to the increasing likelihood of an upcoming Fed rate cut and is just getting started. It eventually forecasts the 10-year yield falling another 200 basis points based on historical precedent of dramatic declines in yield during the interim period between the Fed’s final rate hike and first rate cut.
There have been five hiking cycles since 1988. Each saw a major rally in Treasuries once the hikes were complete. The largest decline was 163 basis points, while the average decline was 107 basis points. The drop in yields tended to abate once the Fed began cutting rates. This cycle Bank of America sees the 10-year yield dropping to 2.25% by May 2024 which is when the first hikes are expected to take place.
Such a decline in Treasury yields would have major implications for other asset classes as well. The researchers also warned that this prediction could be impacted by ‘lingering inflationary pressures. Interestingly, the bank’s strategists have a different outlook as they expect the 10-year period to end next year at 4.25%, which indicates minor change from current levels.
Finsum: Bank of America shared historical research which shows that the 10-year yield tends to experience weakness during the interim between the Fed’s final hike and its first rate cut.
There is increasing signs of a turnaround in the bond market given compelling valuations, attractive yields, and indications that the Fed is done hiking rates. While many investors will instinctively look to move into passive fixed income funds, active fixed income offers some specific advantages.
Over the last decade, active fixed income managers have outperformed their benchmark more than 75% of the time even after taking all fees into account. According to Joseph Graham, the Senior Managing Director, and Head of the Investment Strategist Group at Lord Abbett, this is due to several unique factors which make the fixed income market inefficient.
The primary reason is that institutional fixed income investors such as banks, insurance companies, and central banks make decisions based on non-economic factors such as regulations or market stability. This can distort pricing and create opportunities for savvy managers.
Another inefficiency is that benchmarks are weighted by the amount of debt outstanding. This means that borrowers with considerable amounts of debt are overrepresented. Similarly, indices often have constraints around size and maturity, creating opportunities for alpha around these under-owned securities. Asset managers with teams that specialize in a particular niche are particularly well-suited to discovering such pricing discrepancies.
Finsum: Active fixed income has outperformed passive fixed income funds. Some of the reasons that the fixed income market is inefficient are because many market participants have non-economic incentives and indices are skewed to overrepresent borrowers with considerable amounts of debt.
The last thing a retiring financial advisor might want to consider is making a significant change to their business. Their focus is often on finding the perfect partner to join their practice so they can transition out over the next few years. However, an overlooked option with significant benefits lies in switching broker-dealers.
Think of it as a reverse recruitment process. Just as firms entice top advisors with cutting-edge technology, competitive compensation, and career development opportunities, these same features can attract a larger pool of potential buyers for a practice. Joining a progressive firm can also expand an advisor's recruitment options, giving them access to a broader range of advisors who might be interested in taking over their business.
Making a switch might seem like extra work at the tail end of a career, but the advantages can be substantial. By aligning with a forward-thinking firm, an advisor may find a smoother transition to their succeeding partner and potentially even a higher purchase price for their practice. Advisors should not dismiss the power of changing broker-dealers as part of their succession plan – it could be the key to a successful and rewarding exit.
Finsum: Financial advisors planning their succession should explore how switching broker-dealers could be their ticket to a rewarding exit.
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Alternative investments have captured the attention of institutional investors for decades, with private equity making up the lion's share of the alts category. Today, however, private credit is making waves and grabbing its piece of the investment pie.
As recently noted by Institutional Investor, "private credit has arguably become the most powerful transformational force in the financial world since the 2008 economic crisis." This rise to prominence can be attributed to a confluence of factors. Traditional lenders, reeling from the recent banking crisis, have become more risk-averse, leaving a gap in credit availability. Stepping into this void are alternative investment managers, offering much-needed capital to businesses.
With some investment managers now packaging their private credit holdings into vehicles accessible through financial advisors, an entirely new world of opportunity has opened to individual investors, allowing them to diversify their portfolios with this exciting asset class.
Private credit presents a compelling option for advisors seeking to enhance portfolio diversification and reduce correlation. While the credit crunch of early 2023 has eased, private credit firms remain active, diligently finding new markets to deploy their capital. If this trend continues, it ensures a steady supply of investment opportunities for both institutional and individual investors.
Finsum: Learn how the surge in private credit is creating portfolio diversification options for both institutional and individual investors.
Alternative investments can add value to portfolios by boosting returns and leading to increased diversification according to a recent UBS white paper on the subject. Within the category, it favors specialist credit hedge funds, macro hedge funds, secondaries in private equity, and specific types of private debt. However, it does note that investors should be aware that there is a tradeoff in terms of reduced liquidity.
The firm recommends a 20% allocation and believes that it could lead to an annual increase of 50 basis points in the long term. It’s increasingly of interest given the asset class’s strong performance in 2022 when stocks and bonds both delivered double-digit, negative returns. In contrast, most diversified alternatives’ indices saw performance between -6% and +17%. In terms of forward returns, the bank forecasts return between 6% and 11% over a full business cycle.
In terms of specific strategies, UBS recommends specialist credit hedge funds which focus on differences between strong and weak companies. It also favors secondaries in private equities and notes some attractive discounts in the space. The bank also sees upside to private debt given that yields are around 12% with lower default risk than high-yield credit.
Finsum: UBS is bullish on alternative assets. It believes that the asset class can boost returns while also increasing diversification.
The last FOMC meeting saw the Fed put a pause on hikes. Recent economic data, specifically softer inflation prints, is also supporting the notion that the Fed’s next move will be to cut rather than hike. Adding fuel to the rally was comments from Fed governor Christopher Waller that Fed policy was ‘well-positioned’ to bring inflation back down to its desired level. Waller’s concession is noteworthy given that he has been among the most hawkish FOMC members.
It’s already resulted in longer-term yields dropping, as the 10-year yield has declined from 5% in mid-October to 4.3%. As a result, equities have surged higher, and bonds posted their best monthly performance in nearly 40 years. The Bloomberg US Aggregate Bond Index was up nearly 5% in November. This performance is likely to attract inflows especially as bonds will further strengthen if the economy does fall into a recession.
With these gains, the asset class is now slightly positive on a YTD basis. Many investors may also be eager to lock in these rates especially as the ‘higher for longer’ narrative around interest rates seems to be passing. There’s also increasing chatter of a rate cut as soon as spring of next year, while the odds of another hike have diminished.
Finsum: Bonds enjoyed a strong rally in November. Some of the major factors behind this strength were dovish comments from FOMC members, soft inflation data, and the Fed nearing the end of its hiking cycle.