Wealth Management
2023 has been quite different compared to 2022 especially from a financial markets perspective. Due to raging inflation and a hawkish Fed, 2022 saw weakness in both stocks and bonds. In contrast, both asset classes have delivered positive returns in 2023 YTD despite significant and continued headwinds.
This is particularly the case for active fixed income. In an article for the Financial Times, Madison Darbyshire and Harriet Agnew highlight how large asset managers have been increasing allocations to the category as they look to lock in higher rates with the Fed in the final innings of its rate hikes. Analysts are noting demand from institutional and retail investors, across the active fixed income spectrum.
In 2022, $332 billion moved out of the category, but 2023 has already seen inflows of $100 billion in the first third of the year. This trend is expected to only strengthen with active fixed income ETFs expected to continue taking a larger share of the fixed income and ETF universes. According to State Street CEO Yie-Hsin Hung, "It feels like the beginning stages of what happened in equities.”
Finsum: After a poor 2022, inflows into active fixed income are sharply higher as they look to lock in higher rates given the end of the Fed’s tightening and increasing odds of a recession.
According to an article by Katherine Greifeld and Emily Graffeo, Blackrock is launching its own ETF for income investors. This marks new fixed income CIO Rick Reider’s first ETF launch.
The actively managed BlackRock Flexible Income ETF will invest in more higher-yielding parts of the fixed income spectrum like high-yield bonds, emerging market debt, and securitized assets. It will have an annual expense ratio of 50 basis points and will be managed by Rieder, Jacob Caplan, and Samir Lakhani.
Fixed income ETFs are experiencing rapid growth in terms of inflows and new issues due to high rates and an uncertain economic outlook. Many analysts anticipate ETF flows to become a dominant factor within the fixed income market like ETFs have for equities. Within the category, Blackrock is the leader with $600 billion in assets out of a total of $1.4 trillion in fixed income ETFs.
According to Blackrock, these ETFs are serving investors while also leading to more liquidity in fixed income markets. BINC carries an annual expense ratio of 50 basis points and is actively managed by a team including Rieder, Jacob Caplain and Samir Lakhani.
FinSum: Blackrock is the leading issuer and manager of fixed income ETFs. Recently, it launched the Blackrock Flexible Income ETF which invests in higher-yielding debt.
With interest rates at their highest level in decades and an increasingly cloudy economic outlook, it makes sense that interest in annuities has increased. Used properly, annuities can create a steady income and reduce overall portfolio volatility.
However, Allan Roth in a Barron’s article shares some risks that investors need to consider before investing in an annuity. In terms of simple annuities, there are two main kinds - single premium immediate annuities and multi year guaranteed annuities.
He says that a single premium immediate annuity is similar to a pension. Typically, these are bought through an insurance company, and it pays a defined amount every year. The benefits are that it provides cash for the rest of a clients’ life. But, the risk is that the value of this income can be diluted by inflation. This becomes more germane the longer the annuity is relied upon.
The other option is a multiyear guaranteed annuity which provides income for a certain period of time, typically between 5 to 10 years. This functions similarly to a certificate of deposit. Yields are slightly higher than a CD especially with longer durations. However, the higher yield does come with higher risk as CDs are backed by the FDIC while these annuities are backed by insurance companies which come with higher levels of risk.
Finsum: Annuities are seeing higher levels of demand due to increasing recession risk and high rates. Yet, there are some risk factors that investors need to consider.
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While model portfolios are gaining in popularity, there are some notable detractors such as Lifeworks Advisors CEO Ron Bullis who criticized model portfolios for not providing enough customization for clients. His comments at the WealthStack Conference were covered by Patrick Donachie for WealthManagement.
Specifically, he believes that the risk scores used by model portfolios are not effective indicators of the actual risk faced by clients which can vary by large amounts. He believes that the industry is falling short on meeting the needs of clients especially in a world of increasingly personalized services that are immediately available.
Due to the ubiquitousness of smartphones and finance apps, the cost and inconvenience of switching advisors has dramatically declined. This is a major change from the previous decade. And, we saw a taste of this during the collapse of Silicon Valley Bank with $42 billion in customer deposits exiting the bank in days as rumors of a collapse spread.
Advisors need to start thinking about this new reality as competition for clients could also increase. They need to clarify and understand what is unique about the services they are providing to their clients and need to proactively take steps to grow the relationship with clients.
Finsum: With technology comes inevitable change, financial advisors need to prepare for a world where clients are much more proactive in switching firms due to digitalization.
Regulation Best Interest (Reg BI) was passed by the SEC in 2019 and implemented in 2020. It essentially requires brokers to only recommend products to customers that are in their best interest. It also requires that brokers must inform clients of any potential conflicts of interest and financial benefits they may accrue.
Until recently, enforcement of Reg BI has been lacking, but this is clearly now changing as authorities are stepping up. The most recent incident is FINRA fining five broker-dealers for failing to comply with regulations including Reg BI and Form CRS.
These firms were cited for a lack of guardrails and protocols that would lead their registered brokers to adhere to Reg BI. Relatedly, these firms were also penalized for missing deadlines related to Form CRS and/or providing incomplete information. Form CRS is an overview of a broker’s services, fees, conflicts of interest, prior disciplinary action, and other information to increase transparency and minimize fraud risk.
The five firms did not admit or contest FINRA’s decision. Like previous Reg BI enforcement, the penalties and citations were minor. In contrast, the SEC has only filed one major Reg BI case, but it pursued much harsher penalties.
Finsum: Reg BI is a new regulation which mandates that broker-dealers must inform clients of any conflicts of interest and recommend products that are in their best interest. Recently, regulatory authorities are stepping up enforcement.
One reason for the growing popularity of direct indexing is tax-loss harvesting. However, many investors fail to capture the full benefits, because they are manually reviewing their portfolio for these types of opportunities.
In an article for Vettafi’s Direct Indexing Channel, James Comtois shares why automation is essential to unlocking the full benefits of direct indexing. With direct indexing unlike investing in indexes, losing positions can be sold to reduce an investors’ tax liabilities. Then, these proceeds can be reinvested in similar assets.
However, the more frequently these opportunities can be uncovered, then the greater the potential alpha. Therefore, investors should look to automate this process in order to capture the most benefits. Unfortunately, many advisors continue to do this process on an annual or quarterly basis which means they are missing many opportunities.
With the right software, these scans can be conducted on a daily or weekly basis, leading to more consistency and better outcomes in terms of tax savings. Automation can also help advisors find the best rebalancing opportunities. Overall, more frequent scans can lead to between 20 and 100 basis points of additional returns.
Finsum: Direct indexing is rapidly growing, but many advisors fail to capture its full benefits, because they are not automating the process of finding tax-loss harvesting opportunities.