April 22, 2012

Alternatives & Annuities: The Right Mix for Advisors?

It’s a new world when it comes to baking alternative investments into variable-annuity contracts, experts say

Despite the plethora of investment- and payout-options with available variable annuity contracts, advisors often focus on the tried-and-true reasons for using them with clients.

Dean Zayed, JD, LLM, CFP and CEO of Brookstone Capital Management LLC in Wheaton, Ill., cites two primary reasons for recommending VAs. 

“One is to get a tax-deferred growth vehicle for a client, inside of which we would like to access some of the alternative space,” he says, in an interview with AdvisorOne. “A typical client there could be a 45-year-old doctor who’s in a high tax bracket, doesn’t need an income rider or a death benefit, likes the tax-deferral and is looking for maximum growth.

“The second scenario typically,” explains Zayed, “is where we’re using the income rider where we have kind of a lifeboat built into the VA where it is a growth-engine. You still get tax-deferral but the primary purpose is to have this guaranteed future income stream which you can set up now by buying a rider.”

As Zayed mentions, the option to consider alternative investments within a VA is attractive.

Tom Cochrane, CFA, publisher of the Annuity Digest, agrees.

“I think that the alternative market is here to stay, and that applies to the retail sector, as well,” Cochrane says. “That makes sense given what’s gone on over the past several years, in 2008, etc.

“People don’t simply want to be pegged to what goes on in the broader market,” he adds. “They want to have some sense of kind of downside protection and hedging, etc., and it’s also a difficult return environment for people.”

That interest among advisors and investors has led Jackson National Life to recently introduce its Elite Access VA, which includes alternative investments as a core part of its offering. (AdvisorOne’s March 6 article discusses the product; more product details are available online

The unanswered question, of course, is whether investment advisors will move client assets into alternatives within the VA contracts.

So far, at least, it’s been less a flow of funds and more a trickle of assets among VAs that offer alternatives, says Frank O’Connor, product manager with Morningstar’s Annuity Research Center.

“What I can tell you is that at least so far [alternatives are] a pretty small overall number in terms of assets under management within variable annuity products,” O’Connor explains. “As of the end of 2011, there were approximately $1.5 trillion invested in VA products and just something a little bit under $2.5 billion of that is in alternatives.”

Even within the alternatives allocations, however, investors aren’t straying far from traditional asset classes.

O’Connor notes that 60% of the $2.5 billion is in long/short equities. Managed futures is the second-largest allocation with about 20% of the $2.5 billion in managed futures, and the rest is made up of bear-market strategies.

In contrast, large-blend funds have about $230 billion, and allocation funds have over $300 billion (of the $1.5 trillion VA total).

Those relatively conservative selections frequently are influenced by product requirements.

The allocations “are driven a lot by the living benefits that very often require a fund-of-funds with a specific asset-allocation model in use that helps the issuer control, or at least to some degree, manage their risk of offering those guarantees,” he says. “So, that’s where you tend to see the asset concentration when you look at the industry as a whole.”

Despite the low adoption rates of alternative strategies, O’Connor believes the Elite Access product may appeal to advisors because it takes a different approach than its competitors.

“It’s one thing to talk about the use of alternatives and how long there have been products out there where alternative asset classes have been available,” he says. “I would say that that’s distinctly different from Jackson National’s new product, where the alternatives form a very core part of the strategy of the product itself.

“In that sense,” O’Connor states, “it’s a rather different animal, and I haven’t seen exactly its equivalent yet. I think we’re just going to kind of sit back and watch how this product does out in the marketplace and how well it resonates with its target audience.”

 

 

 

 

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