PGIM, the investment management arm of Prudential Financial, launched two new laddered funds of buffer ETFs: the PGIM Laddered Fund of Buffer 12 ETF (BUFP) and the PGIM Laddered Fund of Buffer 20 ETF (PBFR) on the Cboe BZX. These ETFs offer U.S. large-cap equity exposure with limited downside protection and an upside cap on appreciation. 

 

BUFP invests equally in 12 PGIM U.S. Large-Cap Buffer 12 ETFs, while PBFR invests in 12 PGIM U.S. Large-Cap Buffer 20 ETFs. These funds, the lowest-cost buffer ETFs in the market with a 0.50% net expense ratio, aim to help investors navigate market volatility. 

 

Buffer ETFs provide the advantage of downside protection during market declines but come with the disadvantage of capped gains during market rallies.


 

Finsum: Lowering the costs of buffer ETFs could be wildly beneficial particularly when they seem so well poised for our current environment. 

Artificial intelligence is becoming crucial in financial advisory operations, automating tasks and enhancing efficiency. This allows advisors to focus more on client interaction and strategic work.

 

 AI leverages big data and advanced analytics to identify patterns, detect market trends, and anticipate client needs with greater precision. Consequently, clients receive more personalized advice and recommendations. 

 

Additionally, integrating various financial technologies enhances client engagement and produces better outcomes. The rise of open architecture ecosystems enables the integration of best-of-breed solutions tailored to a firm’s specific needs.


Finsum: AI tools can be used for simpler tasks like client outreach and personalization but also for more advanced tasks like portfolio construction. 

The first five months of 2024 have featured above-average volatility for fixed income due to inflation continuing to run hot and increased uncertainty about the Fed’s next move. Despite these headwinds, institutional investors have been increasing their allocations to long-duration Treasuries and high-quality, corporate bonds.

One factor is that there is increasing confidence that inflation and the economy will cool in the second half of the year, following a string of soft data. As a result, allocators seem comfortable adding long-duration bonds to lock in yields at these levels. Many seem intent on front-running the rally in fixed income that would be triggered by the prospect of Fed dovishness. According to Gershon Distenfeld of AllianceBernstein, “History shows pretty consistently that yields rally hard starting three to four months before the Fed actually starts cutting.” 

For investors who believe in this thesis, Vanguard has three long-duration bond ETFs. The Vanguard Long-Term Bond ETF is composed of US government, investment-grade corporate, and investment-grade international bonds with maturities greater than 10 years. For those who prefer sticking solely to bonds, the Vanguard Long-Term Treasury ETF tracks the Bloomberg US Long Treasury Bond Index, which is composed of bonds with maturities greater than 10 years old. 

Many allocators are adding duration exposure via high-quality corporates given higher yields vs. Treasuries. These borrowers would also benefit from rate cuts, which would reduce financing costs and boost margins. The Vanguard Long-Term Corporate Bond ETF tracks the Bloomberg US 10+ Year Corporate Bond Index, which is comprised of US investment-grade, fixed-rate debt issued by industrial, financial, and utilities with maturities greater than 10 years. 


Finsum: Interest is starting to pick up in long-duration bonds following softer than expected economic and inflation data, which is leading to more optimism that the Fed will cut rates later this year.

According to Lindsay Rosner, the managing director of multi-sector fixed income investments at Goldman Sachs, fixed income is presenting investors with an attractive opportunity to lock in high yields without compromising on quality. There are some challenges given divergences in central bank policy around the world and increasing uncertainty about the timing and direction of the Fed’s next move. Overall, the firm believes that the status quo of ‘higher for longer’ is likely to prevail.

A major factor is inflation, and the economy proving to be more resilient than expected. As a result, the market is now expecting two quarter-point rate cuts before the end of the year, compared to expectations of 150 basis points in cuts entering the year. The next Fed decision is on July 29. Prior to that meeting, there will be considerable amounts of inflation and labor market data, which could impact its thinking, although the current expectation is for it to hold rates steady.

With rates at these levels, there is increased risk that consumer spending is affected or that a higher cost of capital begins to impact corporate profitability and hiring. This risk increases the attractiveness of fixed income, especially as many investors are looking to rebalance given strong equity performance. Rosner sees opportunity in higher-quality areas such as investment-grade corporate bonds and structured products with AAA or AA ratings, especially given an impressive carry differential over Treasuries.


Finsum: Goldman Sachs sees opportunity in higher-quality segments of the fixed-income market. It believes investors should lock in yields at these levels, given the risk that high rates will eventually sour the economic outlook. 

In the past two years, retirement investors have funneled over $20 billion into US exchange-traded funds (ETFs) that limit both gains and losses, challenging traditional insurance products. These "buffered" ETFs capitalize on derivatives to cushion the effects of extreme market swings and have grown popular since their 2018 debut, especially after the market turbulence of 2020 and 2022.

 

The draw of buffered ETFs lies in their downside protection, which has become increasingly attractive to investors seeking to safeguard their retirement savings. Financial advisers in the US have embraced these ETFs, driving $10 billion in net inflows in both 2022 and 2023, while taking market share from the $3.3 trillion annuities market and costly structured notes.

 

This has grown not only the size but the scope of the market with 200+ defined outcome ETFs in the US, totally a staggering $37bn. In turn new competitors like BlackRock and AllianceBernstein are joining the competition to try and capitalize on the gains from First Trust and Allianz. 


Finsum: The uniqueness of buffer ETFs really is in how they integrate derivatives to drive performance and outcomes and can present nearly all in one solutions. 

What is the best way to manage a portfolio in an era with less structural disinflation, and how can you improve upon the 60/40 in the current environment 

 

 The traditional 60/40 portfolio, consisting of 60% stocks and 40% bonds, has long been a benchmark, balancing growth from stocks with stability from bonds. However, the historical success of this model relies on a period of declining interest rates and favorable economic conditions in the U.S., which may not persist in the future. 

 

As interest rates stop declining and inflation potentially rises, the performance of the 60/40 portfolio is expected to be less impressive, especially during high inflation periods when energy and commodities tend to outperform. To better manage portfolios in this new environment, it’s advisable to diversify beyond the 60/40 mix by including assets like commodities, real estate, and cash equivalents to hedge against inflation and provide more stability during economic shifts.


Finsum: We have seen an increased correlation between stocks and bonds in the most recent years suggesting alternative diversification to manage volatility. 

In its Q2 active fixed income commentary, Vanguard discussed lowering rate hike expectations for 2024 due to strong economic data, while inflation remains stubbornly above the Fed’s desired levels. 

Despite the odds of a soft landing declining, Vanguard’s base-case scenario is that the Fed is done hiking and will hold rates at these levels until later this year. A risk to the firm’s outlook is inflation lingering above 3%, which would spark discussion about the need for further rate hikes. 

It sees monetary policy as remaining data-dependent and notes that the Fed has limited room to maneuver. The central bank risks another surge in inflation by cutting rates too soon, but it also risks a prolonged recession by cutting rates too late. 

Despite this uncertainty, Vanguard believes that there will be opportunities amid higher market volatility. It recommends investors take advantage of locking in attractive yields for longer durations and sees potential for better risk-adjusted returns in bonds vs. equities. Over the next 5 years, Vanguard forecasts returns of 4.5% for stocks and 4.3% for bonds. However, bonds are expected to have one-third of the volatility of stocks at 5.2% vs. 15.8%. 


Finsum: Vanguard shared its quarterly active fixed income outlook. The firm is downgrading its expectations for rate cuts in 2024, given recent economic data. Instead, it sees more opportunities in other parts of the fixed-income market.

2024 has proven to be a year of relentless volatility for fixed income, given mixed signals about inflation, the economy, and monetary policy. However, there are plenty of opportunities to make money amid these conditions. 

A consequence of high rates is that the US government is expected to pay more than $1 trillion in interest to bondholders this year, which is more than double the average from the previous decade. Currently, all Treasury securities are yielding more than 4%, and due to elevated rates, investors have a higher margin of safety. This means that fixed income is once again a source of meaningful income for investors and serves as a counterweight to equities.

Deal flow also remains robust, which is a positive for underwriters and sponsors. According to Bloomberg, bankers who underwrite bond offerings are expected to see a 25% increase in bonuses. In terms of sales and trading, bonuses are expected to rise by 20%, compared to an increase of 5% to 15% for equities. 

Another trend in fixed income is the electronication of the bond market. Traditionally, bond trading has been done over the phone or through banks, which has resulted in illiquidity and less price discovery. 

Now, volume is moving to electronic bond exchanges, which is benefiting market makers like Citadel Securities and Jane Street. These firms are now making markets in government and corporate bonds. It’s estimated that 42% of investment-grade debt trades were electronic last year, compared to 31% in 2021.


Finsum: Entering the year, many were confident that Fed rate cuts would fuel a bull market in bonds. This has failed to materialize, but there have been opportunities in fixed income.

April was marked by a mean reversion as robust inflation data and continued economic resilience dampened expectations of Fed dovishness later this year. As a result, flows into equity ETFs dropped from $106 billion in March to $41 billion in April. 

In contrast, flows surged into fixed income ETFs, increasing more than 60% to $27.4 billion. Lower-risk government bond ETFs attracted the most inflows at $10.1 billion, which was the highest since October of last year. Within the category, short and intermediate-term Treasuries captured the most inflows. 

In the US, flows into fixed-income ETFs were greater than equity ETF flows, at $15.2 billion vs. $14.1 billion. Scott Chronert, the global head of ETF research at Citi, noted “US-listed ETF flows decelerated this month against a generally risk-off backdrop. Underlying trends also pointed to more cautious positioning. Fixed income led all asset classes, but the gains were skewed towards core products, shorter durations, and Treasuries.”

Until something material changes in regard to inflation or the economy, it’s likely that investors will continue to favor ETFs that benefit from short-term rates remaining higher for longer. 


Finsum: Fixed income inflows into ETFs sharply increased in April, while equity inflows declined. This was a downstream effect of reduced expectations of Fed rate cuts in the second half of the year due to an uptick in inflation.

Investors are finding increasingly innovative ways to invest in private markets and interval funds are one of the latest trends developing in this area. Interval funds enable individual investors to commit to strategies that invest directly in private markets, while listed private equity ETFs invest in public firms offering private-market strategies. 

 

There has been a spike in interest for alternatives and uncorrelated assets, benefiting interval funds. High-net-worth investors now have access to private capital managers previously exclusive to pension funds and sovereign wealth funds, but accessing and managing the required capital remains a challenge. Private-market funds, including variously named private market access and opportunity funds, address this need and saw significant growth with 11 new products launched in 2022, a trend continuing in 2023. 

 

Although these funds offer unique advantages like access and diversification, they come with high costs, potential liquidity issues, and commitment periods that can lock up capital, necessitating careful consideration by investors.


Finsum: Liquidity lock up should be highly considered for these types of alts, and the current high rate environment can exacerbate this problem. 

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