Bonds: Total Market
According to the study, nearly two-thirds of financial advisors state that they are primarily influenced by factors within their own practice when constructing portfolios. Conversely, these advisors are less likely to take input from their broker dealer (B/D) or custodian. The divergences between advisor channels pose challenges for asset managers in establishing their products and services effectively.
Cerulli suggests that asset managers concentrate their distribution efforts on channels where advisors rely more on internal portfolio construction methods. Furthermore, the research highlights that advisors within the independent registered investment advisor (RIA) channel tend to construct portfolios internally, followed closely by hybrid RIAs.
Asset managers who allocate distribution resources towards channels such as independent and hybrid RIAs, where advisors tend to make their own investment selections, may have an advantage in portfolio construction.
Finsum: Independent RIAs help meet their clients’ needs with better portfolios.
A financial advisor survey by Capital Group reveals a surprising lack of understanding about active fixed-income ETFs. Despite growing demand, less than 4% of assets are allocated to them, with limited advisor confidence in using them.
Surveyors highlight the benefits of active fixed-income ETFs, including consistent returns, portfolio diversification, and potentially lower fees. This knowledge gap, especially among wirehouse advisors, may be due to their recent introduction.
Younger advisors seem more receptive, suggesting wider adoption as awareness grows. Capital Group believes active fixed-income ETFs will bridge the gap with passive options, urging advisors to prepare for client interest.
Finsum: Macro climates like the current one almost always give bond pickers and edge, and advisors are missing alpha.
Treasury yields jumped higher following the hotter than expected March CPI report. The 10-year Treasury yield moved above 4.5%. It has now retraced more than 50% of its decline from its previous high in late October above 5%, which took it to a low of 3.8% in late December, when dovish hopes of aggressive rate cuts by the Fed peaked.
Clearly, recent labor market and inflation data have not been consistent with this narrative. In March, prices rose by 3.5% annually and 0.4% monthly, above expectations of a 3.4% annual increase and 0.3% monthly gain. Core CPI also came in above expectations.
Instead of trending lower, inflation is accelerating. Now, some believe that the Fed may not be able to cut rates given the stickiness of inflation. Additionally, economic data remains robust, which also means the Fed can be patient before it actually starts lowering the policy rate.
Some of the major contributors to the inflation report were shelter and energy costs. Both were up 0.4% and 2.2% on a monthly basis and 5.7% and 2.7% on an annual basis. Shelter, in particular, is interesting because its expected deceleration was central to the thesis that falling inflation falling would compel the Fed to cut.
Finsum: The March CPI came in stronger than expected, leading to an increase in Treasury yields. As a result, we are seeing increasing chatter that the Fed may not cut at all.
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Following the better than expected March jobs report showing a gain of 303,000 jobs, Treasury yields moved higher across the curve. The 10-year yield initially rose 14 basis points to a new 2024 high of 4.43% before backing off a bit. Overall, the jobs report reduces the urgency of the Federal Reserve to cut rates given the labor market’s resilience.
Going into the report, consensus expectations were for an increase of 200,000 jobs, which would be a softening from the 270,000 jobs added in February. It adds to the data showing inflation moving sideways rather than lower over the past couple of months.
Yields also rose on Thursday following comments from Neel Kashkari, President of the Federal Reserve Bank of Minneapolis, questioning the likelihood of rate cuts if inflation continues to linger above 2%. As a result, the odds of the Fed not cutting rates at the May and June meetings have increased.
Some other positives from the report were the unemployment rate declining to 3.8%, despite an increase in the labor force participation rate to 62.7%. Average hourly wages increased by 0.3% on a monthly basis and by 4.1% annually. Both figures were in line with expectations. Job gains were strong across the board, with the biggest contributors being healthcare, government, leisure and hospitality, and construction.
Finsum: Treasury yields moved higher following a stronger than expected March jobs report. Overall, the report led to a decrease in the odds of a rate cut at upcoming Fed meetings.
Over the last year, there has been an increase in the accessibility and availability of direct indexing solutions. Still, the category continues to be dominated by high net worth or ultra high net worth investors. According to Anton Honikman, the CEO of MyVest, there is about $400 billion managed by direct indexing strategies. He anticipates that the next stage of growth for direct indexing will depend on younger and less affluent investors.
Initially, the primary advantage of direct indexing was that it allowed investors to extract tax alpha. He forecasts that as direct indexing becomes democratized over the next few years, providers and advisors will have to make some adjustments.
He notes that custodians will have to offer fractional share support for the technology to work for smaller investors, as implemented by Schwab and Fidelity, which now offer direct indexing to investors with lower minimums.
Typically, there is some premium involved with direct indexing over investing in low-cost ETFs. Given the increase in ETF options over the last couple of years, he believes that it marginally erodes the use case of direct indexing for many investors. Over the longer term, he sees the direct indexing premium compressing in order to remain viable vs. a portfolio of low-cost, targeted ETFs. Further, he believes that the next wave of direct indexing will be driven by younger investors who want to align their portfolios with their values rather than optimize their tax situation.
Finsum: At one time, direct indexing was only available to high or ultra high net worth investors. As it becomes democratized, here are some considerations for providers and advisors.
Unlike mutual funds or ETFs, personalized indexing permits harvesting losses at the security level, offering more opportunities for ultra-high-net-worth investors to capture additional tax advantages. Tax-loss harvesting involves selling an investment at a loss and reinvesting the proceeds into another asset, a key benefit of direct indexing.
Direct indexing strategies involve selling stocks below their cost basis and instantly repurchasing correlated replacements to avoid wash-sale rule violations. Since investors own individual stocks in their portfolios, losses can be captured even when the index gains value. DI experts exemplifies this strategy by selling underperforming securities during market gains, using harvested losses to offset capital gains and taxable income up to $3,000 annually, with the option to carry over losses to future years.
Maximizing tax alpha depends on the frequency of portfolio scans for harvesting opportunities, with daily scanning potentially improving after-tax returns by 1% to 2% or more. Commitment to direct indexing underscores its importance in tax-efficient investing.
Finsum: The frequency through which a portfolio can be scanned for tax-loss harvesting is making the case extremely compelling for direct indexing.