Model Portfolios Can Help Increase Income on a Portfolio
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.
2 Components of Direct Indexing
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.
Volatility Continues to Baffle Investors
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.
Analyzing Active Fixed Income ETF Outperformance
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.
Short-Term Fixed Income ETFs an Intriguing Option
2022 was one of the worst years in memory for fixed income amid raging inflation and a hawkish Federal Reserve. Yet, conditions are much more favorable for the asset class in 2023 given a slowing economy and decelerating inflation. In an article for TheStreet’s ETF Focus channel, David Dierking discusses why short-term fixed income ETFs are a compelling option.
While, it’s likely that the Fed is done raising rates for now, the resilient economy and labor market mean that rates are likely to stay ‘higher for longer’. This favors fixed income with shorter maturities as investors can take advantage of high yields.
ALready, we are seeing this manifest as short-term bond ETFs were the recipient of 21% of net bond ETF inflows in Q1, even though they only account for 8% of the fixed income universe by total assets.
Additionally, many investors treat short-term bond ETFs as a cash equivalent given that they are extremely liquid, while paying generous yields. In fact, Fed policy is essentially encouraging this trade given the extremely inverted yield curve and rally in long-duration fixed income since March of this year.
Finsum: Short-term fixed income ETFs are seeing major inflows this year and are an intriguing option in the current market environment.