Wealth Management
It’s an interesting time for fixed income given the recent rally and optimism around inflation falling enough to cause a change in Fed policy. In conversations with clients, Nicholas Bragdon, Lord Abbet’s Associate Investment Strategist, discussed some common themes that are emerging.
The first is that many clients report feeling satisfied with earning 5% returns in deposits and have no desire to make a change. While returns on cash are the highest in decades, the same is true across the fixed income universe even in short-duration assets like short-term corporate debt. Historical data also shows that being overweight in cash leads to long-term underperformance while also leading to reinvestment risk in the event that the Fed does start cutting rates.
Another common concern among clients is that they believe they will have sufficient time to make changes to their portfolio if the Fed does start cutting rates. However, history shows that it’s quite difficult to time these changes in rate policy.
In fact, last year at this time, the consensus was for the economy to fall into a recession in the second-half of the year, leading the Fed to start cutting rates. In reality, markets are too efficient and will have already priced in a bulk of gains by the time the Fed actually starts easing. Thus, investors should consider moving from cash or short-duration fixed income into intermediate or longer-duration to take advantage of the changing environment.
Finsum: Fixed income markets are at an interesting place, following a strong rally to end the year amid anticipation of a change in monetary policy. Here are some common client concerns.
According to Broadridge Financial, we are on the cusp of a meaningful shift in the wealth management universe as direct indexing represents the next evolution of passive investing. Over the last 20 years, we have seen exchange traded funds (ETFs) displace mutual funds as the primary vehicle for investing. Now, Broadridge believes something similar is happening with direct indexing.
Some of the major reasons for this are low trading costs, fractional shares, and technology advances which make it accessible and practical for investors with much lower amounts to invest. Direct indexing assets are forecast to rise at a 12.4% rate over the next few years, outpacing ETFs, mutual funds, and SMAs. As a result, it’s becoming imperative to offer this service to clients who are particularly amenable to its tax optimization and personalization features.
Despite these trends, Broadridge reports that only 47% of executives and advisors were familiar enough with direct indexing to complete a survey about the subject. Additionally, only 14% of advisors currently recommend it to clients. According to the firm, advisors and practices should move quickly to embrace this technology as it has the potential to be a source of differentiation and value for clients. Client interest is especially high among Millennials and Generation Z due to their desire to align their investments with their personal values.
Finsum: Broadridge Financial conducted a survey of advisors and executives about direct indexing. Despite promising long-term trends, it found that many are still not acting to embrace this opportunity.
Blackrock remains the heavyweight when it comes to the ETF market in terms of total assets and issues, but rivals are catching up. As of November of last year, Blackrock managed 32% of total assets in the US ETF market, a slight drop from 33.7% at the same time last year. This figure was at 39% just 4 years ago.
Blackrock’s major rival in ETFs is Vanguard. While Blackrock has ETFs for nearly every category, Vanguard is focused on fixed income and equities while sticking to its reputation for low costs and diversification. Recent flows into ETFs have favored cheap index funds which is one factor in Vanguard taking some market share. Vanguard has seen its market share rise from 25% to 29% over the last 4 years.
The story is different in Europe, where Blackrock retains its dominance. As of November 2023, the firm had 44% of total ETF assets, and this figure was unchanged over the last 5 years despite the European ETF market more than doubling. Overall, Blackrock has $9.1 trillion in assets and is expected to have net inflows of over $250 billion.
Blackrock has the benefits of a first-move advantage in Europe and has developed relationships with institutions. In Europe, investing continues to be driven by institutions rather than retail traders.
Finsum: Blackrock remains the clear, global leader in ETFs. However, Vanguard is catching up especially in the US, where its index funds are seeing rapid growth.
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Active ETFs represent a fraction of the overall market of investable assets, but the future looks very promising given current growth rates. This is evident through the bevy of new active ETF launches which will continue in 2024. Last year, 75% of ETF launches were active. Additionally, according to Cerulli, 95% of ETF issuers have existing plans or are planning to launch active ETFs in the coming year.
Some of these active ETFs will be conversions of active mutual funds, while others will follow a dual-class structure. In terms of why active ETFs are gaining traction, the biggest factor is the tax benefits of the ETF structure. In contrast, many investors in active mutual funds may find themselves with a tax bill if the fund takes profits on winning positions.
Additionally, the fee structure of ETFs is much simpler while it also leads to more transparency for investors. This appeals to many investors who are then able to hedge risk more effectively. Currently, most of the focus on issuers is for transparent, active ETFs with 59% of launches falling in this category. One caveat is that active ETFs have failed to penetrate the institutional market as 80% of assets currently come from retail investors.
Finsum: Active ETFs had a strong year in 2023 and even more launches are planned for 2024. Here are the major factors driving the category’s growth.
Annuity sales are expected to remain strong in the coming year on the heels of another record breaking year of sales in 2023. Whether 2024 sees another record year of sales ultimately depends on the economy and interest rates. Notably, the Life Insurance Marketing and Research Association (LIMRA) sees these favorable economic trends, such as volatility in financial markets and uncertainty about the economy and Fed policy, continuing.
LIMRA notes that rates are likely to continue declining, which could also lead to a surge of sales as buyers may be eager to lock in rates at these levels. If financial markets continue to move higher, demand for products with lower risk like fixed indexed annuities and fixed-rate deferred annuities may decline while demand for registered indexed-linked annuities will climb.
2023 was rare as nearly all categories saw growth. The highest rates in decades propelled sales of fixed annuities, while uncertainty around the economy and monetary policy drove growth for annuities offering downside protection.
If the Fed does start to cut rates as anticipated, LIMRA projects that sales growth will eventually be impacted especially for more rate-sensitive products. In total, it forecasts sales between $311 billion and $331 billion depending on the trajectory of interest rates.
Finsum: Annuity sales are forecast to remain strong in 2024. However, sales could slow when the Fed does actually start cutting rates as this would impact returns.
When it comes to investing for retirement, most think of IRAs and 401(k)s due to the unique tax advantages. However, there is a tradeoff as these accounts tend to be less flexible. According to Christine Benz, Morningstar’s director of personal finance and retirement planning, there are some upsides to investing for retirement in taxable accounts.
These advantages include the ability to save and invest as much money as available, withdraw funds with no penalty or limitations, and no constraints on investment choices. Using taxable accounts for retirement investing is also necessary for ‘super-savers’ who have maxed out contributions to tax-advantaged retirement accounts.
Benz notes that with the right selection of investments, the taxable account can become as tax efficient as an IRA or 401(k). Additionally, it can help with financial goals of a short or intermediate nature like a down payment for a house, a remodeling project, or a vacation home.
She notes that model portfolios are well-suited for tax-efficient investing in taxable accounts. She recommends structuring these model portfolios into 3 components. One is a liquidity basket for short-term spending needs, a high-quality municipal bond fund basket that is geared for withdrawals between 5 to 8 years, and the rest invested in a globally diversified basket of equities.
Finsum: For retirement investing, there is still a place for taxable accounts especially for specific purposes. Here’s how to use model portfolios to achieve these goals.