According to Russell Investments, the outlook for active fixed income looks quite attractive in 2023. They see opportunities to outperform benchmarks due to market and trading inefficiencies, index construction, and a volatile macro environment due to the lack of clarity around the Fed’s hiking schedule.

Compared to active equity funds, they see more opportunity for alpha in active fixed income for a variety of reasons. A major one is that fixed income indices are constructed with thousands of securities, often with different durations, coupons, and covenants. For astute managers, this can create opportunities to uncover value especially amid rating changes, new issues, and rebalancing by indexes. 

Another favorable factor is that many participants in the fixed income market are not focused on maximizing returns. Instead, there are forced buyers of fixed income due to capital requirements like insurance companies and banks. Further, central banks remain active in these markets as well, and they telegraph their intentions well in advance. 

Finally, there are simply more inefficiencies in fixed income as the vast bulk continue to be traded over-the-counter which leads to less price transparency and wider bid-ask spreads. 

Finsum: Russell Investments sees opportunity for investors in active fixed income funds due to more inefficiencies, less transparency, and more opportunities to uncover value..

Be a pal, huh, and give it a little elbow room. Fueled by institutions and financial advisors intent on seeking to tailor traditional indexes to meet the preferences of beneficiaries, direct indexing’s growing – and quickly – according to al-cio.com.

While direct indexing isn’t exactly new to the rodeo, its use has been spurred by current day computing power, according to a report by Jason Kephart, Morningstar’s director of multi-asset ratings, and his team.

Now, keep in mind, it’s not only your clients with the greatest wealth and complex investment portfolios who should be riding the direct indexing bandwagon, according to Randy Bullard, global head of wealth at Charles River Development, reported investmentnews.com.

“I think every financial advisor should be accessing direct indexing for their taxable client accounts,” Bullard said at the recent ETF Exchange conference in Miami.

“A direct indexing solution is uniquely designed to catch money in transition, and it’s suitable for all types of investors,” he said. “That’s the transition the industry is starting to go through. Once you conquer the operational complexities of direct indexing, it becomes a broad market solution.”

Last year, transitions among financial advisors lost a little ground, according to Investnews.com, reported linkedin.com.

But, tada, independent broker-dealers picked up almost 1,000 advisors in 2023.

The morale of the story? The volume of transitions is secondary; in the world of recruitment, what reigns supreme is lassoing top producers capable of expanding the business.

Up to date technology’s one way snag advisors.

One word to capture technology’s role in drawing fresh talent: “significant,” according to Jim Frawley, CEO and founder of Bellwether.

“Good technology is a game changer and committing to the tech of the future will be very attractive to those being recruited,” said Frawley. “This includes adopting certain aspects of AI and automation and at least being open to investigating other opportunities to free up time and elevate them. Advisors today are looking at tech to make their offering more attractive and substantial. Tech is also becoming their biggest competitor.”

And you might say recruiting pays off.

For example, leveraging its organic recruiting initiatives, during this year’s first quarter, Cetera Financial Group layered on nearly $3 billion in assets under administration, according to thinkadvisor.com.

In a recent Bloomberg article, Katherine Greenfield discussed the growing popularity of triple-leveraged bond ETFs. It’s somewhat surprising given that the bond market is coming off its most volatile year in 2022 in decades given the challenges posed by rising rates and sky-high inflation. 

Further, bond investors tend to be more conservative and favor the asset class, because it is less volatile than equities. Similarly, there has been an uptick on call and put buying on fixed income ETFs as well. To compare, there were 827,000 contracts traded on the iShares 20+Year Treasury Bond ETF in 2013, while there have been more than 2.2 million contracts traded on the same ETF this year.  

Overall, there are 15 leveraged fixed income ETFs, listed in the US. Total assets have climbed to $3.5 billion with the largest being the 20-Year Treasury Bull 3x which provides exposure to longer-term Treasuries and uses derivatives to track its underlying index. So far, this ETF has already seen $720 million in inflows, nearly eclipsing last year’s total of $783 million. According to Greenfield, the inflows into leveraged fixed income ETFs are likely due to retail traders, while the spike in options activity can be attributed to institutional investors.

Finsum: Leveraged fixed income ETFs are experiencing massive inflows, while options activity on fixed income ETFs is also soaring. . 

According to research from the Indiana University Kelley School of Business, the current strength in real estate may prove to be transitory. Currently, the housing market has remained resilient despite higher rates due to a demographic bulge and low inventory of available homes. 

However, Indiana University’s research indicates that demographic-driven demand is at a peak. Coupled with low supply, this is likely to drive prices higher in the near-term. However, there is likely to be long-term slowing in demand due to slower population growth and an aging population, barring an unforeseen surge in immigration or household formation.

Additionally, baby boomers are likely to start downsizing, while lower fertility rates also mean that demand for housing will be structurally less. Due to the pandemic and increase in remote work, there was a surge in household formation that exceeded population growth over the last couple of years. This trend is also unsustainable given demographic realities. 

The rise in mortgage rates has also artificially constrained supply as many would-be sellers are not selling due to locking in low rates. Yet, this is simply ‘pent-up’ supply that will be released into the market once rates decline or through the passage of time. 

Finsum: Real estate has continued to hold up well despite deceleration in economic growth and higher rates. However, this state of affairs looks unsustainable in the longer-term.

In an analyst note, JPMorgan’s Chief Equity Strategist Marko Kolovanic discussed the anomaly between an increasingly shaky market and economic outlook, in contrast to the S&P 500 volatility index (VIX) which continues to trend lower. 

A week ago, the VIX dropped to 16 which is its lowest level since November 2021, despite the S&P 500 being 16% lower compared to 17 months ago. Yet, economic growth continues to decelerate, inflation is meaningfully higher, and the Fed remains in a hawkish posture. 

Kolovanic notes that we are not likely to see any abatement of these pressures in the coming months given the tightening of financial conditions and rising recession risk, while the Fed’s priority remains stamping out inflation even at the expense of the economy and labor market. Further, he notes stress in the banking system and drumbeat of rising tensions regarding China, Russia, and an upcoming election cycle.

He says depressed volatility is due to technical reasons, primarily the selling of short-term options which leads to dealer buying of stocks and volatility leaking lower. Adding to this is continued resilience in Q1 earnings while many were anticipating a meaningful decline. 

Finsum: Volatility is at 17 month lows despite stocks being much lower. JPMorgan’s Marko Kolovanic explains some reasons behind this discrepancy. 

Josh Schwaber discussed how model portfolios can help improve the client experience in a recent article for InvestmentNews. 

The biggest benefit is that it allows advisors more time to spend with clients to understand their needs and goals rather than portfolio management. After all, an advisors’ long-term success is dependent on retaining and attracting clients.

However, many clients fail at this critical step and don’t establish trust with their clients. Further, they aren’t successful at giving advice that applies to financial health from a holistic perspective and instead focus on investment recommendations. 

Model portfolios are a great solution to this dilemma as it allows advisors to spend more time on clients and their needs. They also allow advisors to grow their practices to a bigger size due to standardization and the consistent analytics offered by model portfolios. 

Further, model portfolios lead to less time spent on managing portfolios, yet there is no tradeoff in terms of returns. They allow advisors to leverage institutional resources, while still allowing for customization to account for a client’s specific goals. 

Overall, model portfolios allow clients to grow their practices to an even larger size with no tradeoff in terms of client service. 

Finsum: Model portfolios are an invaluable tool to help advisors grow their practice, while still maximizing time spent on understanding and serving clients. 

In an article for Financial Planning, Victoria Zhuang discussed the brisk pace of recruitment for financial advisors in the second-half of 2022 despite a volatile and challenging market environment. 

According to Diamond Consultants, there was a 12% increase in the number of experienced brokers who switched firms. This is a contrast to the typical pattern of advisor movement and recruitment slowing down in volatile conditions. 

In the first half of 2022, 4,249 experienced brokers switched firms which increased to 4,757 advisors moving in the second-half of the year. In total, more than 9,000 experienced advisors moved which was slightly more than 3% of overall advisors in the US. 

In addition, transition deals were much more generous in the past, indicating that the wealth management industry remains competitive and ambitious in terms of recruitment and growth. This is also reflected in the generous deals offered to entice movement with many signing deals paying more than 300% of 12-month revenue. Another noticeable trend is gains made by independent broker dealers, while the big banks continue to see outflows of experienced brokers to these smaller firms. 

Finsum: 2022 was a banner year for the recruitment of experienced advisors. This is in contrast to the typical pattern of muted recruitment during shaky markets.

In an article for the Globe and Mail, Tom Czitron shared some thoughts on why investing in alternative asset classes could get more challenging over the next decade. He defines alternatives as any asset that is not an equity, bond, or a money market fund.

The most well-known examples are hedge funds, private equity, natural resources, real estate, and infrastructure. Typically, there is low correlation with stocks and bonds which increases diversification and long-term returns. 

Yet, there are some challenges as returns can widely differ. Additionally, there is less coverage and data regarding the alternative investments unlike stocks and bonds where there is Wall Street coverage, regulatory disclosures, and publicly available information. For advisors, this means that more judiciousness is required in terms of selection. 

Another complicating factor is that alternative investments are generally illiquid. While this does likely contribute to the asset class’ enhanced returns, it means that funds cannot be easily withdrawn with long lock-up periods in many cases. An additional risk is that many alternative investments deploy large amounts of leverage which mean there is a greater risk of a blow-up in the event of a rate shock or bear market. 

Finsum: Alternative investments outperformed stocks and bonds over the last decade. Yet, there are some risk factors that investors need to consider.

A recent blog post by the UBS Chief Investment Office analyzed the performance of active fixed income managers in 2022. Given the rise in rates and challenging macro environment, it’s not surprising that there was a large dispersion in returns which rewarded active managers who were able to successfully navigate the turbulence. 

Another factor contributing to this dispersion was the outperformance of short duration bonds as compared to longer duration ones. Similarly, floating rate bonds also outperformed vs fixed rate. In municipal and corporate debt, higher quality outperformed lower quality. 

As a result, many active fixed income managers were able to outperform their benchmarks. However, there are some challenges when it comes to assessing active manager performance. Fro one, fixed income indices’ individual holdings are often illiquid and don’t reflect transaction costs. 

With these caveats in mind, there are still some important takeaways to consider. Active managers tend to perform better in less efficient markets, where there is more opportunity for alpha. Additionally, active managers tended to outperform when they had more flexibility to take advantage of various drivers of potential outperformance. 

Finsum: Active fixed income managers outperform vs passive indices in 2022. Here are some reasons why.