The Fed’s Bond Market Gift to Investment Advisors

The Fed’s Bond Market Gift to Investment Advisors

Create insured portfolios with Treasuries plus ETFs.

Reviewed by: Staff
Edited by: Ron Day

Investment advisors spend a lot of time searching for ways their clients can have their cake and eat it too. For some, Federal Reserve Chairman Jerome Powell has this message:  

Happy Birthday! Now, eat your cake. 

When Powell summarized the current Fed posture on future interest rate hikes last week, he included the words “not assured” (he also uttered obscenities caught on audio). Perhaps the irony is that on the day he talked about closing doors and keeping interest rates elevated, he kept the door wide open for investment advisors to use bonds and ETFs to create what are effectively “insured” portfolios.  

Despite this week’s reaction from stock and bond markets, risk as we know it hasn’t come to an end. The Fed is open to rate hikes, to “higher for longer.” 

Meanwhile, shorter-term Treasury rates aren’t shifting, meaning advisors can still craft a one-two punch of a portfolio allocation that locks in a worst-case scenario, with upside uncapped. Furthermore, this can be entirely customized at the client level. It adds up to the type of differentiation many advisors crave to grow their practices. And it takes very little time and effort, as the advisor gets to play innovator and, dare we say, hero. 

Treasuries Plus ETFs—How it Works 

Using a basic conceptual example, applied to a hypothetical $100,000 portfolio, this is how you do it: 

  1. Five-year US Treasury zero coupon bonds currently sell for about $80. As advisors know, that means an $80 investment gets you $100 in five years when the bond matures. The bonds are liquid and easy to purchase on behalf of clients. So step one would be to invest $80,000 in such bonds, and plan around the fact that the full initial $100,000 will be intact at the end of five years, barring a failure to pay those bonds by the US government.  
  2. That leaves $20,000 uninvested. That can be invested in whatever the advisor decides is best for each client. For simplicity, let’s just say it is placed in the SPDR S&P 500 ETF (SPY). The advisor can create a more diversified model portfolio, use buy and hold or tactical management, incorporate options and stocks, etc. This is simply a “growth” portfolio, 20% of the initial asset base to complement the “government guaranteed” 80% described above. 

Now, let’s examine a potential range of outcomes. I looked at every five-year rolling period for SPY, including dividends, since its 1993 inception. The best cumulative five-year profit it has had was the amazing 250% gain ending in late 1999. Its worst five-year drawdown was 35%, which ended in March of 2009. If we take past as prologue, and assume those are the best and worse case scenarios for that $20,000, by the time the $80,000 in zero coupon bonds has grown to $100,000 five years later, the $20,000 could be worth as much as $70,000 or as little as $13,000. Add back the $100,000 bond maturity value, and we get an “expected” range of possible outcomes for the $100,000 starting value of between $170,000 and $113,000.  

That’s an annualized return of between 11.2% and 2.5% over five years. Most importantly, even if the advisor took extreme risks with the growth portion of the portfolio, invested in speculative options that expired worthless, the original $100,000 would still be worth $100,000. The $80,000 grew to $100,000 and the other $20,000, sadly, lost 100% of its value.  

Bond Market, ETF, Opportunities

This just scratches the surface of what is possible in today’s investment climate. But it should make two things crystal clear for advisors, or retail investors who like what they read here and want to consider it for themselves.  

  • The bond market is offering opportunities to create “insured” portfolios to an extent we have not seen in 15 years. 
  • The extremely wide range of ETFs now available (over 3,000 to choose from) makes an ideal “playing field” for that growth portfolio. 

It has been a “bull market” in investment complexity this entire century. But sometimes, what clients want is an investment plan simple enough that their advisor can write it down on a proverbial cocktail napkin. That’s what this concept aims to provide as food for thought to advisors and investors.  

Rob Isbitts was an investment advisor for 27 years before selling his practice to focus on ETF research and education. He is based in Weston, Florida. Contact him at  [email protected] and follow him on LinkedIn.