By Cyril Tuohy
Financial advisors who want to boost yields on bond portfolios may consider a range of alternative investment strategies. These strategies can improve the performance of fixed-income portfolios.
Some of the alternative investment categories are “absolute return,” “distressed debt,” “equity market neutral,” “event-driven” or “equity hedge.”
Other categories are “merger arbitrage,” “macro CTA” and “relative arbitrage,” said Steve Young, chief investment officer and senior vice president of the asset management group for Curian Capital, the asset management subsidiary of Jackson National.
The alternative strategies are designed to improve portions of a bond portfolio in a rising interest rate environment, which has been the case since last spring. Advisors, however, should use these strategies only to complement a portion – up to 30 percent – of a client’s bond portfolio.
“For investors that need the potential to earn something more than money market yields, that's where the eight alternative investment categories come in,” Young said in an interview with InsuranceNewsNet.
With the 10-year Treasury note yielding less than 3 percent, investors and their advisors would love to eke out more from their life insurance policies and their annuity contracts. “For investors that need the potential to earn something more than money market yields, that’s where the eight alternative investment categories come in,” he said.
As a group, Young said, those eight alternative investment strategies “fared measurably better” than investment-grade bonds.
Young, one of several experts who spoke last month at Jackson’s Generation Alt Virtual Conference, delivered a presentation titled “Alternatives for Addressing Interest Rate Risk.” The conference was attended by 464 financial advisors.
“We define ‘Generation Alt’ as the new era of investors looking for additional methods to diversify their portfolios, given continued volatility and increased correlations in the market,” Clifford Jack, executive vice president and head of retail for Jackson, said in a statement.
Advisors are more interested in alternative investments today because such investments have become more accessible for retail investors through mutual funds. Within mutual funds, alternative investments are relatively liquid and can be held inside or outside of individual retirement accounts (IRA) and some variable annuities, Young said.
Advisors looking to manage interest rate sensitivity within the bond fund world have options as well, Young added.
One strategy used by bond funds is to shorten both the duration of the bonds and exposure to interest rates.
“Another strategy is for advisors to go outside the U.S. and look for bond funds with international exposure seeking to avoid the interest rate pressures here in the U.S.,” Young said. “Adjustable-rate bond funds can also help reduce the sensitivity to rising rates.”
After months of flat or declining rates, interest rates rose steeply in the second quarter and bond funds suddenly delivered negative returns. This was due to bonds’ well-documented inverse correlation between yield and price.
As a result, advisors found themselves bombarded by clients’ questions about managing bond investments.
That’s when Young began introducing advisors to the “Rule of 1.”
“When it comes to interest rates and bond values, for every 1 percent change in rates there’s an approximate and opposite 1 percent change in the value of bonds for every year of duration of those bonds,” Young said.
In the second quarter, the market saw a full percentage jump in the 10-year Treasury yield and a drop in the price of bonds, Young said.
But that was hardly the end of the bond tale. In September, the Federal Reserve surprised many observers of its stimulus package by not easing back from its monthly purchase of $85 billion worth of bonds. Interest rates subsequently have eased, as well.
“They went from a lot of taper talk, to a taper balk,” Young said.
Jackson’s Generation Alt summit on alternative investments was timely for advisors who heard Young and other professionals talk about alternative strategies.
“They each did a deeper dive of their strategy and why people should be doing something differently in their portfolios and how to go about it,” said Mark Jones, vice president of marketing for Jackson National Life Distributors in Denver.
Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected].
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