How do advisors feel about current markets?
Financial advisors recently surveyed1 by Natixis Investment Managers are concerned. The survey found that a vast majority (82%) of advisors believe the prolonged bull market has made investors complacent about market risk. While over half of advisors themselves are concerned about market volatility (61%) and stock valuations (52%), they are also worried about planned increases in short-term interest rates and the effects on the markets.
Contending with rising rates
The Federal Reserve Open Market Committee has clearly telegraphed an intention to continue increasing the Fed Funds rate, the rate banks charge each other for overnight lending which drives short-term interest rates. As a result, over half (59%) of advisors cite interest rate hikes as a top portfolio risk, and nearly three-quarters (74%) express concerns about bond market volatility due to current US monetary policy.
Half of advisors (50%) report using bond duration management as a primary strategy for positioning client portfolios in anticipation of rising rates. While this is one strategy, diversifying the low-risk portion of an investment allocation by adding non-interest rate sensitive strategies also may help. For example, low volatility2 equity strategies that strive to reliably reduce equity market volatility and downside risk may help offset the possible negative effects of future interest rate increases. The equity exposure of these strategies has historically had low correlation to the bond market and may provide greater long-term return potential than bonds in a period of low to rising interest rates.
Advisors and clients could be looking for alternatives
Alternative strategies3 such as low vol equity may be coming to the fore, with 80% of advisors recommending alternatives to their clients and nearly a third (31%) reporting an increase in clients asking for these types of strategies relative to three years ago. Led by real estate and real estate investment trusts (REITs) (50%), other types of alternative investments most frequently recommended include hedge fund4 strategies (24%).
Potential uses of alts in a portfolio
Alternative strategies can address specific objectives including diversification, risk (and volatility) management, return enhancement, fixed income replacement and a hedge against inflation. Many advisors indicate they use select alternative strategies to meet these various objectives. Sometimes strategies can meet more than one of these objectives. For example, low volatility equity strategies can help manage equity volatility, complement fixed income assets as a portfolio stabilizer, and achieve greater portfolio diversification.
Cost considerations remain central
Advisors are also focused on cost. Nearly three-quarters of advisors cited lower fees as a primary benefit of passive strategies. Yet, even a diversified portfolio of passive investments offers no proven risk management tools apart from investment grade fixed income, which may be challenged by a low to rising interest rate environment. By contrast, certain low volatility active strategies can limit risk while seeking return.
An insight-driven, active approach
The appeal of active approaches in today’s environment are clear. A majority (83%) of advisors believe the current market environment is likely to be favorable for active portfolio management. Strategies that combine broadly diversified, index tracking equity exposure with active risk management tools may offer the best of both worlds: low costs, tax efficiency, a relatively stable return stream and reliable downside protection.
2 Volatility management techniques may result in periods of loss and underperformance, may limit the Fund's ability to participate in rising markets and may increase transaction costs.
3 Alternative investments involve unique risks that may be different than those associated with traditional investments, including illiquidity and the potential for amplified losses or gains. Investors should fully understand the risks associated with any investment prior to investing.
4 Hedge funds are unregistered private investment pools that are often illiquid and highly leveraged, and may engage in speculative investment practices. Hedge funds may be more volatile than investments in traditional securities and may not be suitable for all investors.
Diversification is the process of allocating capital in a way that reduces the exposure to any one particular asset or risk. A common path towardsdiversification is to reduce risk or volatility by investing in a variety of assets. Duration risk measures a bond's price sensitivity to interest rate changes. Bond funds and individual bonds with a longer duration (a measure of the expected life of a security) tend to be more sensitive to changes in interest rates, usually making them more volatile than securities with shorter durations.
Investing involves risk, including the risk of loss. Investment risk exists with equity, fixed income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
Unlike passively managed investments, there are no indexes that an active investment attempts to track or replicate. Thus, the ability of the investment to achieve its objectives will depend on the effectiveness of the portfolio manager. There is no assurance that the investment process will consistently lead to successful investing.