“May you live in interesting times” is supposedly an ancient curse, although its origins are murky. Still, the saying applies today: We live in interesting times, particularly in the investing world, as financial advisors and their clients face a new reality.
We have entered a completely different financial landscape than the one most of us have experienced. We are seeing the highest inflation in 40 years, rising interest rates, supply chain issues and other ongoing effects of Covid-19. Add to this significant geopolitical turmoil and related energy disruptions. Not surprisingly, this has led to significant market volatility and economic uncertainty.
But challenging periods throughout history have often sparked innovation, renewal and growth, too. In my conversations with financial advisors this year, I have heard many of the questions and concerns they are dealing with from their clients. In response, I have tried to emphasize several themes. First and foremost, I tell them in these times of uncertainty, one thing is certain: The critical role financial advisors play helping clients navigate the market environment is more important than ever. But in addition, there are a number of concrete steps advisors should consider taking for their clients.
Make volatility your friend—or at least not your enemy. The Federal Reserve is raising interest rates, walking a tightrope between tempering inflation, and destroying demand. Fed actions and hawkish rhetoric have fostered increased market risks and higher volatility. And yet, while selloffs are always challenging, it is important that advisors help their clients stay on track to meet their goals, not panic, or try to time the market. At the same time, it may make sense for advisors to position clients for this new environment. For example, many are considering minimum volatility strategies, which as the name suggests are constructed to focus on stocks that have lower beta, meaning they are less volatile than their counterparts. Historically, min vol strategies soften the blow when markets fall, although they may not reach the heights when markets rally. Over the long term, however, they have historically outperformed their non-min vol counterparts. For clients who find it difficult to stomach the roller coaster ride of investing, they may be a good choice. Advisors may also want to look to dividend ETFs as a potential source of income, diversification, value, and quality in client portfolios.
Look at potential inflation hedges. While cyclical drivers of inflation will fade, we expect structural factors will cause inflation to stay higher and more persistent than in recent years. Advisors may want to consider short-term Treasury Inflation Protected Securities (TIPs) for their clients’ bond portfolios. On the equity side, advisors may want to consider increasing client allocations to the energy sector, infrastructure, or the emergent food megatrends, which may provide some resilience in an inflationary environment.
It’s time to bond again with bonds. This has been a challenging year for fixed income, which has seen the biggest sell-off in years as interest rates rose. Nonetheless, it is important to remember the vital role that fixed income plays in a portfolio. We should not lose sight of the fact that over the long term, bonds have historically provided ways for investors to diversify portfolios, seek income and potentially preserve capital. Given the uncertain environment, however, advisors may want to look beyond the traditional broad exposure as represented by the Bloomberg US Aggregate Bond Index, but instead consider more specific opportunities in areas such as floating rate bonds, investment grade credit, high yield and, as I mentioned above, TIPS. Indeed, the BlackRock Investment Institute recently suggested a preference for risk exposure through investment grade credit, rather than equities. Although bonds could still fall further, we are now seeing attractive yields in many segments of the bond universe. These can be easily accessed through ETFs.
Look for long-term opportunities. Advisors may want to consider this year’s market volatility as an entry point for thematic investing in areas like infrastructure, clean energy, and electric vehicles, particularly given recent developments that support some of these megatrends. For example, the 2021 Infrastructure Investment and Jobs Act provides funding for infrastructure projects that should support the theme, as well as billions for clean energy and EV technologies. And the recent Inflation Reduction Act, the largest climate bill in U.S. history, contains nearly $370 billion in funding to support both clean energy projects and electric vehicle usage. These are themes that will play out over the coming decades and represent good long-term investments for many clients.
As many financial advisors have told me, their clients are feeling uncertain, even wary of the future as the economy is slowing, and we may be heading towards a recession. Financial advisors will play a critical role in helping their clients navigate this uncertainty. While advisors face a daunting task of balancing risk management with finding opportunities, the good news is that they have a set of tools to help them in this effort: ETFs provide low cost, flexible access to the wide range of asset classes that can help advisors prepare their clients for the uncertain path ahead.
Armando Senra is head of Americas ETF, and index business at BlackRock.