By Joseph W. Bartholomew, III

bbt-perspectives-changing-landscape

 

Everyone knows that diversification is critical in the construction of investment portfolios. We’ve all heard that bonds are safe and stocks are risky, so most balanced portfolios begin with some variation of 60 percent stocks and 40 percent bonds. Over the past 30 years, a diversified 60/40 balanced portfolio has generated returns nearly as strong as an all-stock portfolio, while offering a much smoother ride!

Bonds have long been the best diversifier for stock market risk. However, investors must now adjust to a changing investment landscape where a 60/40 balanced portfolio may not provide the same return and diversification as it did over the past 30 years. According to Federal Reserve research, current yields are a consistent predictor of future bond returns.

Many remember double-digit interest rates in the 1980s when they bought their first homes. As those high rates declined over thirty years and reached today’s low interest rate environment, bonds produced returns similar to stocks (bond prices and interest rates have an inverse relationship; as interest rates fall, bond prices rise). It will be difficult for bonds to repeat those returns in the years ahead, starting from low interest rate levels instead. Bonds could even affect portfolio returns negatively in a rising interest rate environment!

Going forward, it is important for investors to learn about new diversification strategies and more cost-efficient structures, which may generate similar returns to yesterday’s tried and true balanced portfolio. For many years, institutional investors have enhanced their returns with access to premier money management firms. They have gone beyond bonds by using unique alternative investment strategies to further hedge against the volatility of stocks. Thanks to financial and technological innovation over the past decade, many new products and investment management platforms now provide the same options to affluent investors. Several of these strategies are described in the following.

Exchange-Traded Funds = Cost-Conscious Investor or Trader

An exchange-traded fund (ETF) is a marketable security that tracks an index, stocks, bonds, commodities, or any basket of assets, like an index fund. ETFs provide the flexibility of further diversifying every portfolio with the simplicity of trading a single stock. Due to relatively low investment management expenses, these funds appeal to more cost-conscious investors. Lower costs are one of simplest way to enhance returns! ETFs can be building blocks for any portfolio, or they can be efficiently used to provide access to a wide array of markets, sectors or even countries.

Separately Managed Accounts = Astute Investor

A separately managed account (SMA) is a portfolio of securities directly owned by the investor and managed according to a specific style by a professional investment manager. SMAs are not a new product to the world of affluent investing; however, technological advancements now allow asset management platforms increased access to exclusive managers, and with lower account minimums and lower investment management expenses. SMAs offer numerous tax advantages, as well as the ability to customize portfolios. For example, you may prefer to exclude certain securities or industries due to social, political or environmental concerns.

Liquid Alternatives = Adventurous Investor

Alternatives, in this case, refer to any strategy or asset class other than stocks or bonds, including: hedge funds, managed futures, private equity, real estate, commodities and others. Rapidly gaining attention within the broad alternatives category is the registered structure of liquid alternatives, or liquid alts for short – because these trade daily, similar to a mutual fund. Liquid alts are appealing to sophisticated investors seeking to reduce portfolio risk and volatility, but hesitant of the higher investment management fees, large account minimums, leverage, and restrictive lockups of the typical hedge fund. The correlation of liquid alts to stocks and/or bonds varies depending on the type of strategy, but the objective is similar: Produce positive returns regardless of the market climate.

Unified Managed Accounts = Outsourced Investor

A Unified Managed Account (UMA) is an integrated money management platform consolidating multiple investment options into one single account. This platform uses an overlay technology to coordinate activity among numerous strategies resulting in more tax-aware trading between the managers, simplified rebalancing and continual performance monitoring of the portfolio. UMAs are particularly appealing to sophisticated investors seeking to delegate the investment management of their overall portfolio.

While bonds have provided great portfolio diversification to stocks, the investment landscape is changing. Diversification may prove more difficult than ever in the years ahead. Back in the 1950s, stocks and bonds were the only two asset classes used to build a portfolio. Today, thanks to financial and technological innovation, additional investment products and platforms are now available to enhance returns, lower investment management expenses and/ or minimize volatility. Depending on your investment personality, some of these strategies may be welcome additions to your portfolio. Your BB&T Wealth advisor can help you learn more.

By Joseph W. Bartholomew, III

bbt-perspectives-changing-landscape

 

Everyone knows that diversification is critical in the construction of investment portfolios. We’ve all heard that bonds are safe and stocks are risky, so most balanced portfolios begin with some variation of 60 percent stocks and 40 percent bonds. Over the past 30 years, a diversified 60/40 balanced portfolio has generated returns nearly as strong as an all-stock portfolio, while offering a much smoother ride!

Bonds have long been the best diversifier for stock market risk. However, investors must now adjust to a changing investment landscape where a 60/40 balanced portfolio may not provide the same return and diversification as it did over the past 30 years. According to Federal Reserve research, current yields are a consistent predictor of future bond returns.

Many remember double-digit interest rates in the 1980s when they bought their first homes. As those high rates declined over thirty years and reached today’s low interest rate environment, bonds produced returns similar to stocks (bond prices and interest rates have an inverse relationship; as interest rates fall, bond prices rise). It will be difficult for bonds to repeat those returns in the years ahead, starting from low interest rate levels instead. Bonds could even affect portfolio returns negatively in a rising interest rate environment!

Going forward, it is important for investors to learn about new diversification strategies and more cost-efficient structures, which may generate similar returns to yesterday’s tried and true balanced portfolio. For many years, institutional investors have enhanced their returns with access to premier money management firms. They have gone beyond bonds by using unique alternative investment strategies to further hedge against the volatility of stocks. Thanks to financial and technological innovation over the past decade, many new products and investment management platforms now provide the same options to affluent investors. Several of these strategies are described in the following.

Exchange-Traded Funds = Cost-Conscious Investor or Trader

An exchange-traded fund (ETF) is a marketable security that tracks an index, stocks, bonds, commodities, or any basket of assets, like an index fund. ETFs provide the flexibility of further diversifying every portfolio with the simplicity of trading a single stock. Due to relatively low investment management expenses, these funds appeal to more cost-conscious investors. Lower costs are one of simplest way to enhance returns! ETFs can be building blocks for any portfolio, or they can be efficiently used to provide access to a wide array of markets, sectors or even countries.

Separately Managed Accounts = Astute Investor

A separately managed account (SMA) is a portfolio of securities directly owned by the investor and managed according to a specific style by a professional investment manager. SMAs are not a new product to the world of affluent investing; however, technological advancements now allow asset management platforms increased access to exclusive managers, and with lower account minimums and lower investment management expenses. SMAs offer numerous tax advantages, as well as the ability to customize portfolios. For example, you may prefer to exclude certain securities or industries due to social, political or environmental concerns.

Liquid Alternatives = Adventurous Investor

Alternatives, in this case, refer to any strategy or asset class other than stocks or bonds, including: hedge funds, managed futures, private equity, real estate, commodities and others. Rapidly gaining attention within the broad alternatives category is the registered structure of liquid alternatives, or liquid alts for short – because these trade daily, similar to a mutual fund. Liquid alts are appealing to sophisticated investors seeking to reduce portfolio risk and volatility, but hesitant of the higher investment management fees, large account minimums, leverage, and restrictive lockups of the typical hedge fund. The correlation of liquid alts to stocks and/or bonds varies depending on the type of strategy, but the objective is similar: Produce positive returns regardless of the market climate.

Unified Managed Accounts = Outsourced Investor

A Unified Managed Account (UMA) is an integrated money management platform consolidating multiple investment options into one single account. This platform uses an overlay technology to coordinate activity among numerous strategies resulting in more tax-aware trading between the managers, simplified rebalancing and continual performance monitoring of the portfolio. UMAs are particularly appealing to sophisticated investors seeking to delegate the investment management of their overall portfolio.

While bonds have provided great portfolio diversification to stocks, the investment landscape is changing. Diversification may prove more difficult than ever in the years ahead. Back in the 1950s, stocks and bonds were the only two asset classes used to build a portfolio. Today, thanks to financial and technological innovation, additional investment products and platforms are now available to enhance returns, lower investment management expenses and/ or minimize volatility. Depending on your investment personality, some of these strategies may be welcome additions to your portfolio. Your BB&T Wealth advisor can help you learn more.

About the Author

Joseph W. Bartholomew III

Joseph W. Bartholomew III

Senior Vice President, Financial Advisor

Joe serves as team lead planning and portfolio strategist. Joe earned his B.S. in Business from Longwood University and holds an M.S. in Financial Economics from Virginia Commonwealth University.