The market surprised just about everyone post election, and while the Dow is continuing to soar, advisors should be prepared for what’s coming in the New Year.
“At IndexIQ, we don’t see any major disruptions in market growth, but we are anticipating some significant spikes in volatility and other hiccups throughout 2017—which means advisors should prepare their portfolios accordingly,” says Sal Bruno, CIO at IndexIQ. “There’s the fear that investors will fall into the old trap of ‘buying the rumor, and selling the news,’ which creates artificial spikes and inevitable losses.” IndexIQ provides high quality, cost-effective ETFs, mutual funds, separately managed accounts, and ETF model portfolios that are designed to open the door for all investors to access sophisticated investment products.
To help keep investors on track in the new year, Bruno suggests diversifying portfolios not by asset class—which is often the go-to strategy in the face of rising interest rates—but by strategy. Why? When things go bad, it’s a given that even the most uncorrelated assets will adopt a correlation of one. That’s not much of an advantage. Instead, maintaining an equities-based approach has the potential to deliver positive returns. “By using the same building blocks, but putting them together in different ways, advisors can adjust their portfolios to diversify equity exposure and be much more durable in times of stress.”
Here are three specific strategies that can help:
1. Merger Arbitrage
This standard hedge fund strategy can be used to effectively create low-risk profits, often decreasing the impact of downturns in the equities market by as much as a third. Data has shown that the low market correlation of this strategy delivers positive returns on a fairly consistent level, making it a solid strategy for combating high volatility.
2. Market Neutral
When bouts of volatility are on the horizon, advisors can match long and short positions to reduce risk and pick up several percentage points of low volatility returns during any short-term downturns. Rather than swinging your portfolio from one extreme to the other by moving into an all-cash position, the portfolio can exploit market momentum without taking on the risk of a standard equities-based approach.
3. Half hedge the dollar
While the US has increased interest rates twice in the past 12 months, the rest of the world is on a very different path, which means foreign investments can be negatively impacted. Because currency positions are not reliable—especially in recent years—leveraging currency within a portfolio can add risk. Instead, it may be more prudent to take a 50% hedge on the dollar—an approach that has been shown to reduce the impact of volatility by as much as 70%.
Market volatility isn’t the only thing on investors’ minds. The DOL fiduciary rule has placed advisory fees into the spotlight, so no matter how the new administration opts to handle the actual law, acting as a true fiduciary and lowering costs is something every advisor should be thinking about moving forward. “It’s going to be pretty impossible to put that genie back in the bottle,” says Bruno. “Instead of fighting against the DOL regulations, advisors would be wise to identify strategies to adapt to the new reality—whether it actually becomes a government mandate or not.”
Introducing ETFs to clients may be one of the easiest first steps toward accomplishing that goal. With the increased focus on fees, ETFs offer a low-fee structure that makes them a strong alternative to mutual funds, which are more commonly understood and accepted by consumers.
Issuers are already engaged in a ‘race to the bottom’ when it comes to fees, making the new year an ideal time to introduce the concept to clients and take advantage of the flood of new products coming into play. With ETFs showing a 15-20% growth in products in 2016 and no signs of a slowdown in innovation, there is sure to be an ETF available to fit any strategy.
Bruno says that one of the biggest advantages of ETFs is their ability to support an active/passive mix.
“In times of market volatility, there are conditions where active will outperform passive, and vice versa,” he says. “By using ETFs to strike a balance, advisors can apply active and passive approaches hand-in-hand to support some level of growth—no matter what the markets throw our way in 2017.”
IndexIQ® is the indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs and the principal underwriter of the IQ Hedge Multi-Strategy Plus Fund. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.
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