Financial advisors could add value for clients with exchange traded fund model portfolio strategies in a time when life expectancy is increasing while retirement goals and the need for income are drastically changing.
In the recent webcast, Why Model Portfolios Work in Today’s Dynamic Market, Professor Jeremy Siegel, Senior Investment Strategy Advisor, WisdomTree Asset Management; and Jeremy Schwartz, Executive Vice President, Global Head of Research, WisdomTree Asset Management, helped outline the current state that investors have found themselves in, highlighting the unprecedented stimulus measures that will lead to strong spending and higher inflation next year. The Fed may even let inflation rise much higher than its 2% target and may not tighten unless it reaches 4% to 5% or above. Meanwhile, investors should turn to stocks since equities tend to do well in a moderate inflation environment, especially those that are leveraged.
Looking at the equity market, the S&P 500 Index is trading around a 22 price-to-earnings ratio, compared to its historic 17.1 P/E going back to 1954. The higher P/E ratio means that investors are paying more for each unit of net income, so a stock is more expensive compared to one with a lower P/E ratio. Siegel pointed out that over the past 150 years, the P/E ratio averaged about 15, which corresponds to 1/15, or 6.7% Earnings Yield, or E/P, which may be used as an indicator for long-term real returns. With the S&P 500 Index at about 3368 as of August 14, stocks are selling for about 20 times 2021 S&P Operating Earnings estimate of $163, so a P/E ratio of 20 projects a real return of 5.0% for stocks.
When comparing the expected stock returns ahead to fixed-income markets, the 5% return is almost six percentage points over Treasury bonds, whose real return is now negative when accounting for inflation, which is also expected to rise ahead. This margin between stocks and bonds is called the “equity risk premium,” and the current premium is almost double the historical average of 3% to 3½%.
“Since interest rates may remain low for quite some time, the traditional ’60/40′ portfolio may not get it done from the client’s perspective,” Siegal said.
“Consider increasing stock and reducing bond allocation to achieve income goals and reduce the likelihood of running out of funds. Rising long rates will likely give negative bond returns,” he added.
The stock market has been a consistent and reliable source of returns for long-term investors seeking to grow their wealth.
“Not only have stocks outperformed bonds over time, they have done so with more stable, consistent, and less volatile returns at 20-and 30-year time horizons,” Schwartz said.
As part of WisdomTree’s core investment beliefs, the strategists argued that market-cap weighting is flawed, fundamentals matter, pricing error, and return premia exist, and ETFs can provide distinct benefits over mutual funds. These core beliefs are incorporated in the WisdomTree Modern Alpha model portfolios, which combine the outperformance potential of active strategies with the benefits of passive indexing to offer investors investment options that are built to perform. Specifically, this so-called Modern Alpha model portfolios provides low cost, transparent investment processes, objective systematic and quantitative methodologies, repeatable and consistent processes, rules-based rebalancing, scalable strategies, and outperformance potential.
In today’s market environment, we may find common goals that both pre- and post-retirement investors share, including maintaining or improving their lifestyle, avoiding running out of money as life expectancy increases, ensuring their family legacy or philanthropic goals are met, boosting efficiency and managing taxes. However, we also face some challenges, such as a stubborn lower-for-longer interest rate environment, with expectations for both yields and returns on bonds now lower than they have been historically. Additionally, there is lower forecasted U.S. equity returns after the recent record rally in stocks.
Alternatively, the strategists pointed to the Siegel-WisdomTree Model Portfolios to resolve these concerns, which aim to generate income to maintain lifestyles, constructing globally diversified portfolios designed for more extended time horizons and longer investor life expectations, and create more tax-efficiency through the ETF structure. The Siegel-WisdomTree Model Portfolios are designed to outperform in a risk-conscious way by overweight equities versus fixed-income to mitigate the longevity risk and by tilting toward historical drivers of return like higher dividend yield and low P/E ratios.
Professor Siegel’s research has shown that focusing on dividend paying stocks led to higher returns over time, provided downside risk mitigation during market bubbles, and produced higher income potential than the market.
Specifically, financial advisors can look to the Siegel-WisdomTree Longevity Model Portfolio and the Siegel-WisdomTree Global Equity Model Portfolio.
The Siegel-WisdomTree Longevity Model Portfolio provides for investors with mid-to long-range time horizons who are trying to balance current income needs with longevity risk. The model portfolio was designed to outperform the traditional 60/40 portfolio in a risk-conscious manner by structurally allocating more toward equities over fixed income and tilting toward factors such as dividend yield and low P/E ratios to seek higher income generation and outperformance potential.
The Siegel-WisdomTree Global Equity Model Portfolio also provides for investors with mid-to long-range time horizons who are trying to balance current income needs with longevity risk. The model portfolio includes diversified exposure to U.S. and international stocks, and it tilts toward factors such as dividend yield and low P/E ratios as well.
Financial Advisors who are interested in learning more about model portfolio strategies can watch the webcast here on demand.