New Ways to Help Clients Move Beyond the 60/40 Portfolio
What You Need to Know
The transparent ETF wrapper is increasingly an investment vehicle of choice, especially for taxable accounts.
Advisors have been sidestepping interest rate risk of fixed income and increased correlations between stocks and bonds.
Derivatives became a dirty word during the global financial crisis, but new tax-efficient, transparent, options-based strategies can help clients meet their goals.
The evolution of investment technology, options markets and regulations around derivatives has expanded the solution set that advisors can choose from to design portfolios for retirees and pre-retirees. There are now tax-efficient, transparent, options-based exchange-traded funds that can help advisors better match risk tolerance with desired outcomes for clients who are battling inflation, longevity and volatility.
For those wary of traditional balanced portfolios, like the 60/40 stock and bond mix, options-based, structured outcome strategies that precisely manage risk are stirring advisors’ attention.
In the wake of the global financial crisis, derivatives — securities that extend beyond options into credit default swaps — became a dirty word. Their proliferation, opacity of ownership and mismanagement in risk models became key issues. Over the past decade and a half, however, much has changed to erase that stain, including the maturation of the exchange-listed options markets, centralized clearing, better risk management procedures industrywide and improved plumbing that underpins markets.
Today, innovative exchange-listed options investment strategies built on improved market structure and embedded into the transparent ETF wrapper — increasingly an investment vehicle of choice, especially for taxable accounts — are revolutionizing traditional retiree portfolios beyond classic stock-bond strategies.
Over recent decades, bond funds have typically provided the risk management function in balanced portfolios that most financial advisors suggest to clients nearing or in retirement. Until recently, bonds remained mostly inversely correlated since the late 1990s. Bond prices would rise when stocks — which helped clients grow their savings and outpace inflation — would fall. Baby boomers did very well in a 60/40 portfolio during this period.
Advisors and their clients got a rude awakening, however, in the relationship between yields and bond prices during the recent rate rise cycle. While retirees may welcome higher yields, the value of their bond portfolios took a beating as the Federal Reserve hiked rates at a record clip from March 2022 to July 2023. The bond market remains in its longest drawdown, and the average intermediate-term bond fund is still deep in the red from a peak in summer 2020.
Options, however, allow for systematic risk management strategies that protect a portion, or all, of the downside over an outcome period while allowing an investor to participate in the stock market’s upside to a cap. This measure of equity market-linked capital appreciation potential is typically well more than what can be earned from holding bonds, especially in an environment whereby investors cannot expect significant price appreciation in fixed income funds.
Today, with the federal funds rate more normalized, higher rates allow ETF sponsors to move beyond partial capital protection, or a buffer, to provide full capital protection, or 100% downside protection strategies, with meaningful upside caps. With capital-protected strategies, advisors can trade the certainty of the risk-free rate for the opportunity to gain about double the risk-free rate from linking their capital to the upside of the equity market.
