Alternatives
The term beta represents an investment’s volatility relative to the overall market and is a concept that experienced investors understand well. Beta measures the sensitivity of an investment to overall market movements and is a measure of systematic risk, with the market typically represented by a broad index like the S&P 500.
High beta stocks exhibit more volatility and are typically growth stocks, while low beta stocks are less volatile and often include value stocks in defensive sectors. But this approach should be used when thinking about alternatives because they are being used to balance a portfolio.
Beta can change over time due to economic conditions and changes in a company's operations or industry. When assessing alternative investments, combining beta with correlation provides insight into an investment's potential role in a portfolio, enhancing diversification and risk management.
Finsum: You don’t need complicated financial models to assess beta, and integrating this historical return factor could greatly improve portfolio performance.
There are increasing concerns that a crisis is brewing in commercial real estate (CRE), as over the next couple of years, $2 trillion in CRE loans will need to be refinanced. Previously, there were hopes that macro conditions would soften, leading to lower rates and a more favorable lending environment. Instead, inflation has proven to be more resilient than expected, and expectations of Fed dovishness have been dialed back.
In addition to high rates, major challenges include decreasing demand for offices and rising vacancies, a stricter lending environment, and balance sheet woes at regional banks, which traditionally account for a large share of CRE lending. However, there is significant variance within the CRE market. Areas like data centers, hotels, and industrial buildings continue to show strength, while retail and multifamily exhibit more mixed performance.
If conditions worsen, there is a risk of spillover effects on the broader economy, including decreased lending activity due to losses at banks, lower tax revenue for local governments due to more vacancies and lower property values, and subsequent declines in hiring. However, the consensus continues to be that there won’t be a full-blown crisis as the sector is sufficiently diversified and continues to have strong credit performance despite adverse conditions.
Finsum: Investors should pay attention to the CRE market given the refinancing cliff and challenges posed by higher rates and a stricter lending environment.
Traditionally, fixed income is where financial advisors look to reduce portfolio risk. This is no longer the case in the post-pandemic period, as the bond market has experienced major volatility, which is becoming the norm in a high-rate, high-inflation regime.
Given these conditions, investors may be better off with fixed index annuities (FIAs). Like bonds, FIAs produce income; however, a key difference is that FIAs guarantee an income stream for life as opposed to a fixed period. Another advantage of FIAs is that they have higher earnings potential than bonds, given that many are designed to earn interest based on the performance of an external index like the S&P 500. In contrast, fixed income has significantly underperformed over the last 5 years and failed to beat inflation.
Over long periods of time, costs matter when it comes to long-term investing. Most bond investments have fees that range between 0.5% and 2%. In contrast, FIAs tend to have much lower fees, on average.
In terms of risk, FIA offers full protection of the principal investment. This means that it can be more effective than fixed income to hedge equities, especially in the current environment. Overall, FIAs can be more effective than fixed income, especially for investors who are in or nearing retirement.
Finsum: Advisors should consider fixed indexed annuities (FIAs) as an alternative to fixed income, especially in the current environment. FIAs offer lower costs, more downside protection, and greater potential for appreciation.
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According to panelists at the SALT conference, private credit will continue to experience strong growth over the next few years. Additionally, they believe that reports of banks stepping in to more aggressively compete with private credit lenders are overblown. Instead, there’s more likely to be partnerships between private credit investors and banks in terms of originating deals and arranging terms.
Michael Arougheti, the co-founder and CEO of Ares Management, sees private credit compounding at an annual rate of 15% for the next decade. He sees growth driven by cyclical and secular factors such as companies staying private for longer, the current high-rate environment, and many ‘good’ borrowers with weak balance sheets. Another factor is the billions being raised for private credit funds across Wall Street.
Panelists also agreed that there are many selective opportunities in fixed income and credit at the moment. And more opportunities should emerge over the next year, especially with rates staying higher for longer. Arougheti believes that there will be more opportunities created by the lack of liquidity. This underscores another difference between the current environment and past cycles for distressed debt - weakness is not sector-specific, rather, it’s more rate-induced.
Finsum: At the SALT conference, panelists agreed that despite headlines, private credit markets will see strong growth over the next few years. They also see more attractive opportunities emerging given high rates and limited liquidity.
Entering 2024, the consensus was that the Federal Reserve would be cutting rates in the back half of the year in response to falling inflation and a slowing economy. This has major implications for private real estate, given that trillions of dollars in loans are maturing over the next couple of years.
Yet, economic data and inflation have been more resilient than expected. Now, rate cut odds have narrowed, while there is some chatter that the Fed may have to tighten further. Currently, the Fed continues to signal that its next move is to cut rates, albeit later and to a lesser extent than previously thought.
Still, this is likely to be uncomfortable for many borrowers, as many are holding onto properties based on the belief that rates will be lower, leading to more favorable selling or refinancing conditions. This is especially the case for those exposed to floating-rate debt.
According to Richard Mack, the CEO and co-founder of Mack Real Estate Group, “People are paying to hold assets, but unless rents rise quickly, eventually asset prices will have to adjust to rates instead of hoping and anticipating rate decreases. In essence, you have to pay to wait and see what kind of recovery transpires, which is different from past cycles where interim cash flow paid you to wait for appreciation.”
Finsum: Many were confident that conditions for real estate would improve as the Fed eased policy in the second half of the year. Now, many borrowers are likely to face increased stress as rate-cut expectations have been scaled back.
The 4% rule has become conventional wisdom when it comes to managing finances during retirement. As millions of people enter retirement over the next decade, it may be time to revise this rule, given higher inflation and longer lifespans.
Social Security benefits are typically equivalent to 40% of a retiree’s income. According to TIAA, retirees should consider pairing the 4% rule with an annuity to generate higher levels of income during retirement. This means that a retiree would convert some portion of their savings into an annuity.
In the first year, this is likely to boost income by up to 32% compared to just using the 4% rule. It also leads to more predictable income and shields retirees from market risk. More predictability can also help with more effective financial planning, leading to a more enjoyable retirement.
Treasury Inflation Protection Securities (TIPS) are another method to increase guaranteed income, especially with a ladder across different maturities. It also protects retirees against inflation.
Overall, the 4% rule should be reconsidered, especially in this era. It leads to less spending flexibility and should be augmented with other sources of income. It also doesn’t account for retirees’ individual circumstances, such as tax rates, risk profiles, and cash flow needs.
Finsum: TIAA believes that the 4% rule should be reconsidered, especially for those retiring now. Retirees may need more income and should consider annuities or TIPS.