What's Ahead:
- Retail investors are leaving advisors following poor returns across markets in 2022.
- New approaches to portfolio management are needed, but advisors need not rewrite the book on how to allocate capital.
- Structured notes can complement a traditional portfolio by featuring enhanced market upside participation and higher yields while protecting against downside risk.
Change is in the air. After enduring a drubbing in both the stock and bond markets last year, investors are rethinking not only their asset allocations but also who should be managing their portfolios. And now with new (and arguably more complicated) retirement rules, care of the Secure Act 2.0, investors young and old need good advice, differentiated services, and a portfolio that can protect against volatility.
New World, New Challenges
A recently released post-COVID-19 survey by YCharts suggests investors are at least thinking about switching advisors due to poor performance. More than one in five clients have made a move, with an additional 25% of those surveyed saying they are considering doing so, according to the data. Digging into the details, those more likely to say good riddance to their advisor were the younger crowd—those under 60— as well as investors with more than $500,000.
A Renewed Focus on Performance
After being rattled by rocky markets in 2022, performance was cited as the top driver when selecting an advisor. Other factors included accessibility and having an advisor who has a deep understanding of the individual’s goals and situation. What was startling in the hot-off-the-presses survey was that portfolio performance was so top of mind among clients. Back in 2019, the same survey uncovered that just 38% of people with assets under $500,000 marked performance as the key factor when choosing an advisor. This time, though, 74% of that same cohort underscored performance the most.
The upshot is that performance has brewed to the surface as the most important factor for clients.
So, You Must Beat the Market? Not So Fast.
This presents a problem, right? We all know that beating the market is tough—maybe impossible—when dealing with clients who have vastly different risk preferences and return objectives. Moreover, portfolio managers agree that it’s asset allocation that drives more than 90% of total returns—a revelation made public in the seminal paper by Brinson, Hood, and Beebower (BHB) in 1986. While challenged since then, there is no debate that how you position money among stocks, bonds, alternatives, and cash is critical.
So, what’s an advisor to do with the intimidating task of improving performance when doing so quite often means exposure tomore volatility—a trade-off that is typically at odds with a client’s investment policy statement?
Think differently.
Diversification Just Isn’t What It’s Cracked Up to Be
Focusing too much on asset allocation can result in portfolios overly concentrated on equity risk. According to the 2020 NACUBO-TIAA Study of Endowments, using quarterly data from 2005 through 2020, even a so-called diversified allocation (using the endowment model) in the end sums to holding a portfolio with equity risk of more than 95%.
While there are no doubt benefits to spreading out stock exposure to several geographies, styles, market-caps, and even holding non-public assets, the result is often similar to simply owning a few broad equity index funds, as it turns out.
The 60/40 Mix: Maybe Not Dead, But It’s Definitely at Least Resting
Meanwhile, other traditional methods of investing capital have been stress tested lately, as well. Last year, the classic 60/40 balanced portfolio of stocks and bonds notoriously suffered its worst annual beating since 2008 as equity-fixed income correlations surged to the highest level since the 1990s.
Looking ahead, some strategists are calling for a new regime that is more inflationary over the coming decade-plus, driven by a less accommodative Federal Reserve. That might result in positively correlated stock and bond markets akin to what seasoned investors experienced in the 1970s. Is the 60/40 portfolio dead then? It’s hard to say, but certainly expecting sky-high sharpe ratios from such a strategy should not be used as a base case by financial advisors over the coming years.
Solutions, Not Just Shots Across the Bow
You may be asking, “So, how do I allocate differently? Not just think differently?”
Structured notes can be a solution. Notes offer an effective way to maintain equity exposure—which clients want—while adding risk mitigation without relying too heavily on asset allocation. Consider it like a hedge against misaligned portfolios.
Here’s how it can work: A structured note with a growth objective offers enhanced upside compared to a market index while protecting against a predefined level of downside risk. It does this through its underlying components of a zero-coupon bond and an options package. What works behaviorally with notes is that clients have a better understanding of what their returns will be under different market scenarios.
That certainty helps individuals—particularly those antsy about volatile markets and displeased with recent performance—stick to their plan. And we all know that a strategy that keeps clients grounded helps retain business. Additionally, advisors teaming with Halo can work with structured note subject-matter experts and other resources to use their note allocation, and its beneficial impacts on portfolio risk and return outcomes, to attract new clients.
Notes: The Alternative to Alternatives. A Vehicle for Better Risk-Adjusted Returns.
Structured notes are not like an alternative investment. Think of them as an ‘alternative to alternatives.’ Today’s notes feature low costs compared to those of years and decades ago due to ground-breaking technology (championed by Halo) and market competition. Advisors can access our award-winning platform, which brings together bids and offers from many large financial institutions that post their best prices with transparency.
We mentioned that structured notes can maintain equity exposure. That’s because notes are a vehicle, not an asset class. There are growth notes that can be grouped alongside stocks in an asset mix, while income notes work more like bonds with a generally lower risk profile and higher yield.
Asset Allocation Application
A popular portfolio construction strategy to employ is to hold a mix of low-cost passive mutual funds or ETFs, a few active funds, perhaps some alternative products, and a set of structured notes. Advisors like this construct since notes can be the yin to the active manager’s yang: If active funds underperform, the advisor can point to the differentiated returns of the notes. Then in a down year, selling the active fund, say a large-cap U.S. strategy, and buying a growth note tied to the S&P 500 growth index achieves tax-loss harvesting without encountering a wash sale. Finally, the active fund can also be used to generate liquidity when needed (we call this the “cash toggle” of active funds).
That’s just one example of how incorporating notes into a client’s portfolio can offer relative upside in a way clients can understand.
The Bottom Line
Clients are on the move. And those that aren’t are at least thinking about finding new advisors who think and allocate differently. You don’t have to take reckless risks or throw together portfolios of complicated alternatives to earn better returns, though.
Structured notes can be easily understood by both the advisor and client, and maintain portfolio equity exposure, all while offering a level of downside protection with higher income yield.
