The Federal Reserve recently announced it’s leaving interest rates unchanged and dialing back projections for rate hikes in 2019 due to a slowing economy and tame inflation. Countries such as Germany and Australia also followed suit by pumping the brakes on rate increases, with many set to cut rates if they haven’t done so already. There’s no shortage of unknowns and variables at play in the market right now, and many advisors are thinking about how best to generate income for clients.
As the global economy slows, financial advisors need to appreciate that income strategies that worked in the past may not work in the future.
The Challenges Of Income Investing
It’s important to first understand the pain points that advisors face relating to income investing. A recent survey of advisors commissioned by Columbia Threadneedle found that interest rate changes (69 percent) and balancing income with total return (52 percent) are the biggest challenges for income investing.
The survey also found that a majority of advisors tend to opt for traditional approaches when addressing fixed-income needs. That’s why advisors surveyed favored investment options such as actively managed portfolios (45 percent) and bond-ladder portfolios (29 percent) as their go-to strategy for long-term income for clients. Benchmark ETFs (“bulk beta”) and strategic beta ETFs followed at 14 percent and 7 percent, respectively.
It’s easy for an advisor or wealth manager to stay in their comfort zone and rely on traditional approaches for income investing. But as we will see later, this comes at the price of limiting their possibilities. Solutions like strategic beta can offer broader opportunities—often marrying diversification with risk-adjusted yield or finding ways to isolate quality.
Going Beyond Traditional Asset Classes And Benchmarks
When in doubt, or faced with pricing pressure, many advisors turn to cheap bulk-beta investing for the answer. We also see this in the equity markets. Unfortunately, benchmark investing in fixed income, such as with the Bloomberg Barclays Aggregate Index (the “Agg”), has limitations. For example, the Agg is much less a comprehensive bond index and much more concentrated around U.S. government-issued bonds. Consider that as of March 31, 70 percent of the Agg was in government-backed bonds. Also, advisors should be sober to the illogical inconsistency of using a market-weighted benchmark like the Agg as an investment strategy because it means there is a greater investment exposure to those that issue the most debt.
Thoughtfully constructed portfolios like those found in strategic beta ETFs can be attractive for advisors and their clients since a multi-sector approach is applied in many cases. Diversified rules-based strategies can include components of the bond market that go beyond simply tracking the bond benchmark, which was never intended to be an investment in the first place.
Some argue that asset managers with strong fixed-income capabilities are best suited to develop thoughtfully constructed, passive fixed-income portfolios. It’s what they do. They have years of experience on the active side to draw from, and spend a lot of time thinking about where markets are heading. More importantly, some of them are starting to incorporate their insights into these transparent, strategic beta solutions.