This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by Corey Hoffstein, co-founder and chief investment strategist of Boston-based Newfound Research.
Stocks get all the attention. Perhaps for good reason: The volatility they exhibit means they often have the biggest impact on investor wealth. All that volatility means opportunity, risk and, if we’re being honest with ourselves, quite a bit of excitement.
For many, fixed income is an afterthought. Unlike stocks, the day-to-day for fixed income can be like watching paint dry.
As investors enter retirement, however, wealth accumulation must transform into thoughtful distribution. The new goal should be to maximize withdrawal rates without risking premature erosion of the capital base.
While stocks may remain the focus of the financial media, these investors should turn their eyes toward bonds.
The Tougher 4%
Unfortunately, with the 10-year U.S. Treasury rate below 1.8%, how and where to find yield in the distribution phase has become a struggle. While investors might be trying to achieve the same 4% distribution target they earned a decade ago, 4% represents a very different risk level today.
From a risk perspective, the target level is less important than the spread that the level implies from a baseline benchmark. For example, a decade ago the one-year U.S. Treasury constant maturity rate was 4.9%. Today the same rate is 0.52%. Based on spreads, achieving 4% today is the same as trying to achieve 8.4% in 2006. In a decade, achieving 4% went from nearly risk-less to very risky.
In the accumulation phase, most investors have a shared objective: growth. The distribution phase, however, is highly personalized based on retirement date, total wealth, lifestyle standards, etc.
So while benchmarks are a fine starting point—and may be perfectly adequate as a risk ballast during the accumulation phase—ultimately, the Barclays Aggregate does not care what your withdrawal needs are.
The Fixed-Income ETF Palette
The good news is that the continued proliferation of ETFs gives investors a full palette of fixed-income sectors to paint with to develop highly customized income portfolios.
In our target income suite at Newfound, we evaluate a universe of 29 fixed-income ETFs, covering the spectrum of:
- U.S., foreign developed, and emerging market exposures
- credit risk
- inflation protection
One way we find useful to visualize this universe is to plot the exposures based on their expected-forward-dividend yield (net of ETF expenses) and volatility levels.
Source: Yahoo Finance. Analysis by Newfound Research.
We can see that the benefit of incorporating such a large number of exposures is that it allows us to cover nearly the entire yield/volatility spectrum. This allows us to balance available yield opportunities, corresponding risks, and diversification opportunities to develop highly customized portfolios.