In a blog post for JPMorgan, Nancy Rooney, the Global Head of Managed Solutions, discusses how many investors have been aggressively buying short-duration fixed income given that yields are at their highest levels in decades and economic risks abound. Some of the most prominent ones include a slowing economy that many believe is likely to tip over into a recession, a standoff between Congressional Republicans and the White House over the debt ceiling, a stressed banking system, and a hawkish Fed.

While this move has paid off so far in 2023, Rooney raises some concerns that it may undermine investors’ efforts to reach their financial goals. Having too much allocation to fixed income and being underexposed to equities will hinder portfolio returns in the long-term. In fact, a portfolio solely in Treasuries would have failed to beat inflation over the last 30 years.  

She recommends that investors think about equities as the growth engine for their portfolios, while Treasuries are more of a cushioning. This means that investors should consider using periods of fixed income outperformance to regularly rebalance their allocations in order to stay on track towards their financial goals. 

Finsum: Fixed income has been a strong performer over the last couple of quarters. Yet, it doesn’t mean that investors should go overboard in increasing exposure to the asset class.

Until the last couple of years, there were limited opportunities for investors to earn a decent income from thier portfolios. Now due to the Fed’s rate hikes, the situation is much different as there are plenty of options for investors. In AdvisorPerspectives, Mike Smith and Mary Erwin of Russell Investments detail some considerations to reduce risk while optimizing for yield. 

During the prior decade when low rates prevailed, many investors were forced to invest in riskier securities in order to generate a decent yield like international bonds, infrastructure bonds, and high-yield bonds. Now, investors can earn similar returns with securities that are much less riskier, but Smith and Erwin believe that investors should continue to have diversified exposure to the asset class given that inflation poses a major threat.

If inflation continues to climb, it reduces the value of these cash flows. Therefore, investors should ensure that their portfolios’ income will grow faster than inflation. Model portfolios can play an important role in this process as it can help build a diversified portfolio and offer exposure to a variety of asset classes with more potential for growth in their income streams.  

Finsum: A major challenge for income investors over the next decade is ensuring that inflation doesn’t eat into their portfolios’ income stream. 

In an article for WealthManagement, Iraklis Kourtidis shared his persepctive on direct indexing and what it precisely means. He says that there are two components to direct indexing. The first is that it helps an investor create a custom and personalized index. The second is that it can help with portfolio management to ensure that it tracks a specific benchmark. 

With direct indexing, investors hold the actual securities themselves in a portfolio rather than an ETF or mutual fund which tracks an index. One advantage of this is that it enables an investor to create their own index. Previously, this wasn’t possible as index investing was only possible through ETFs and mutual funds which follow well-known indexes.

Some investors want the benefits of index investing in terms of diversification and low costs. But, they need greater personalization. One approach is to modify an existing index. Another is to create an index from scratch. 

In terms of portfolio management, there are some additional challenges. For one, index holdings need to be constantly rebalanced especially when tax losses are being harvested to offset gains in other parts of the portfolio or when factor scores change. 

Finsum: There are two parts of direct indexing, and each is crucial for success. One involves constructing a custom index, and the second is portfolio management.

There are considerable headwinds facing the stock market and economy such as a hawkish Fed, uncomfortably high inflation, debt ceiling deadline, an upcoming election year, increasing risk of a recession, a potential regional banking crisis, and geopolitical tensions. 

Yet, the volatility index has trended lower for much of the year and is now at its lowest levels in over a year. Ron Isbitts covered this matter and why it could be an opportunity for ETF investors in an article for ETF.com.

If investors believe that volatility is mispriced, then there are some different volatility ETFs to consider. The ProShares VIX Short-Term Futures ETF offers exposure to volatility over the next 1-2 months. The ProShares VIX Mid-Term Futures ETF holds volatility contracts with a duration of 3 to 6 months. 

There are also ETFs for those with a variant view. The ProShares Short VIX Short-Term Futures ETF moves inversely to volatility, allowing holders to profit from falling volatility. For those who want to generate income from volatility, the Simplify Volatility Premium ETF also tracks volatility but also produces a dividend for holders. 

Note that these ETFs tend to have slippage, high costs, and underperform the S&P 500 over the long-term. Thus, they are best used tactically and with discretion.

Finsum: Volatility is declining despite several potent risks for the market. There are several options for investors to consider.

In an article for ETF.com by Michelle Lodge, she examines whether success in portfolio management is a matter of skill or luck. According to survey results from S&P Dow Jones, there is little connection between good choices made by a manager and portfolio performance. 

According to Craig Lazarra, the Director of Index Investment Strategy at S&P Dow Jones, “Our report for year-end 2022 finds little evidence of persistent active management success, despite considering a variety of metrics and lookback periods.” 

According to the research, investors are better off with low-cost, diversified ETFs. Additionally, success in terms of picking stocks and ETFs is not repeatable. Additionally even in a poor year for passive funds, 51% of active managers still underperformed their benchmarks in 2022. 

Another piece of evidence cited is that managers who outperformed in the first half of the last decade, failed to outperform in the second-half of the decade. The same dynamic appears with active fixed income managers with no indication that success in one year is likely to repeat in subsequent years. 

Finsum: Research shows that active fixed income and equity outperformance is unlikely to repeat in following years.