It seems like the old personal finance rules of thumb are dropping like flies. Not long after the 60/40 portfolio was declared dead, the 4% annual withdraw rule was squished in the financial press. This is not necessarily a bad thing, as classic rules of thumb were never ideal for all people, nor were they intended to be. While we may long for the nostalgic simpler times, financial pros have never been better equipped to adapt by directly incorporating specific planning objectives into portfolio construction & investment selection. Technology continues to provide advisors so many advantages including information sharing, processing power and creative tools to efficiently operate in a much more individualized service model for all clientele. Specialist managers can help advisors shape better goals-based investment portfolios within client constraints and help navigate the numerous challenges presented by low interest rates.
Low Interest Rates, the Rule Killer
The main culprit behind each beloved rule’s fall from grace is low interest rates, a story which itself is so tired I sigh while writing. Nevertheless, the impact of persistently low interest rates continues to change the game. When rates are at historically “normal” levels, planning objectives tend to be more easily addressed as a byproduct of asset allocation, ie: bonds offer stability and income, while stocks provide some expectations for portfolio growth over a reasonable amount of time.
Obviously, this has changed dramatically as bonds offer inadequate income and stocks generally carry such high valuations their potential to drive portfolio growth is fundamentally brought into question. This scenario makes volatility and returns sequencing even more critical to investors at or closely approaching their distribution phase of retirement planning. If fixed income positions are merely being held to serve as ballast to equity risk, opportunities for better investor outcomes are probably being left on the table. Low yielding bonds may not only fail to meet income needs but also lose effectiveness as a risk mitigator as the “cushion of the coupon” goes flat.
If the traditional asset allocation framework for portfolio construction alone does not inspire confidence that clients’ goals will be achieved, specific planning objectives may be directly integrated into investment selection. One of the main advantages of outcomes-based investment mandates is that these approaches allow more flexibility to the manager than the traditional risk/return vs benchmark framework. Advisors may choose to partner with specialists to construct client portfolios tailored directly to individual planning objectives as specialist managers tend to think differently and present creative solutions.
Goals-Based Strategic Income
Nontraditional bond and strategic income programs tend to be outcome-focus and may be adopted as a fantastic supplement to the insufficient income currently being produced by traditional core bond positions. To achieve its goal, a strategic income allocation may include various asset classes and fixed income sectors outside of investment grade corporates and treasuries. Additionally, specialized strategic income managers may evaluate various investment structures to identify potential for improved risk adjusted yield. By incorporating a more flexible universe of potential investments, income specialists are able to seek enhanced relative yield through factors often associated with alternatives such as liquidity and carry. The portfolios tend to be nimble as well, often able to capture a “research premium” by working in less-covered markets and securities.
As the income yield from these portfolios may derive from additional sources to the traditional fixed income drivers of return, duration and credit, they may fill a “sleeve” outside of pure equity or fixed when considered from an asset allocation perspective. A strategic income portfolio may fit into an established alternatives allocation or pull assets from both fixed income and equities as a “hybrid allocation” depending on its level of credit, carry, and liquidity premia. The increased income does not necessarily mean increased risk (although it may), rather by potentially substituting different types of risk. For example, a smaller less liquid security may offer better yield than a more liquid security of longer duration and similar credit. This is a key concept for integrating goals-based investment strategies into the common risk budgeting framework for portfolio construction and where a specialist manager can serve as a valued partner to advisors. Many are native to the advisory community and offer bespoke service for financial professionals to help quantify the risk profile and expected outcomes of their strategies in relation to investor risk tolerance and various other components of the client’s complete financial plan. As “the rules” continue to change, goals-focused specialists offer outside-the-box solutions to adapt.