Investors seeking a diversified portfolio can consider an exchange traded fund strategy designed to generate income and manage risk.
In the recent webcast, Targeting High Monthly Income and Lower Risk, Mark Hackett, Chief of Investment Research, Nationwide, outlined the resilient market that has rebounded from its stumbles through the years, with the latest coronavirus pandemic dealing a deep blow. He highlighted the markets embedded healthy recovery as S&P 500 earnings estimates steadily improve. However, he warned that while the aggressive stimulus measures and extended outlook on low interest rates have helped provide a helping hand in troubled times, there may not be more flexibility for another large stimulus.
As we have witnessed in a year of severe volatility, Hackett warned that emotions hurt portfolio returns. Looking at more long-term data for the decade ending 2019, the average equity investor generated an annualized return of 9.4% compared to the 13.6% return of the S&P 500, and the average bond investor saw an annualized return of 0.6% compared to the 3.8% of the Barclays Agg Bond Index.
Julie Ragatz Norton, Director, Nationwide Retirement Institute, Nationwide, warned that irrational decision making among the average investor is rampant. Many clients these days may be looking for safety and predictability, but research in the field of Behavioral Economics suggest that biases and heuristics, or decision-making shortcuts, are more pronounced in novel situations that trigger emotional responses. COVID-19 may be driving counterproductive reactions. So, financial advisors should be in a position to act as the voice of reason in troubled times.
“The insights provided by Behavioral Economics can only take you so far. What is essential is to know your clients and their ‘default style’. A client’s ‘default style’ is the mode in which they feel most comfortable operating – how they make decisions when they are not being coached or coaching themselves,” Ragatz Norton said.
In more uncertain market conditions, these default styles are magnified, with “intuitive and risk seeking” likely to become more pronounced and “cautious and risk avoiding” to become more pronounced as well.
As way to help investors, Nationwide believes financial advisors should consider the perception on the part of their clients and explain that you understand their perspective and worldview, acknowledge their priorities, and value their well-being. Recent research from the Nationwide Retirement Institute indicates that 72% of investors are more likely to continue to work with their financial professional, give them more of their assets, and recommend them to others.
“If empathy drives client trust, and client trust drives the intention to keep working with the financial professional, we need to think less about ‘correcting’ irrational behavior and more about understanding it,” Ragatz Norton said. “Financial professionals need to meet their clients where they are, responding directly to their needs and continuing to help them pursue their goals and objectives.”
While conventional safe-haven assets have lost some of their luster this year, investors seeking to target current income with less risk relative to traditional income-focused investments have turned to the Nationwide Risk-Managed Income ETF (NYSEArca: NUSI). The Nationwide Risk-Managed Income ETF uses an options trading strategy called a protective net-credit collar to generate income. The options strategy sells an upside call option and uses a portion of the proceeds received to buy a put option to hedge downside risk on an underlying portfolio of securities.
Curt Brockelman, Co-Founder and CIO, Harvest Volatility Management, explained that through the combination of income generation and downside protection, NUSI can benefit investors and advisors as it’s a solution that can complement a traditional 60/40 allocation. It can also be used as a bond alternative that affords investors flexibility across varying market cycles. NUSI can additionally serve as a volatility dampener that may augment existing allocations.
NUSI follows a three-step strategy. First, it fully replicates the constituents of the Nasdaq-100 Index. Secondly, the ETF deploys a rules-based options collar strategy that combines a covered call and a protective put. For the covered call component, a near-at-the-money to out-of-the-money Nasdaq-100 Index call option is sold, with the intent of generating options premium. For the protective put component, the strategy uses a portion of the options premium received to purchase an out-of-the-money Nasdaq-100 Index put option, which seeks to fully hedge the portfolio below the current market price and protect against potential losses in the equity portfolio.
Finally, a monthly distribution is paid out using a portion of the net-credit generated by the collar. If there is remaining options premium, the ETF will reinvest in the underlying stocks for potential upside participation.
“Year to date, the downside risk mitigation benefit derived from NUSI’s dynamic collar, specifically the Fund’s constant, fully financed hedge, has generally contributed to a lower level of volatility, relative to other income-oriented investments,” Brockelman said.
“NUSI offered a measure of downside protection during the sell-off triggered in late February, but most notably delivered outperformance relative to the fixed income investments listed as the market recovered in the following months,” he added.
Financial advisors who are interested in learning more about managing risk in a fixed-income portfolio can watch the webcast here on demand.