Putnam Investments today released the first of a series of reports designed to help financial advisors navigate a changing investment universe. The white paper, “Four Strategies for a World of Uncertainty,” focuses on investments that it says can withstand the impact of rising rates, new money market fund regulations, increasing volatility and periods of market uncertainty.
“Today’s financial advisor and investor face a complex web of market drivers and environmental factors that make the task of long-term investing seemingly more challenging and daunting than ever,” said Putnam CEO and President Robert L. Reynolds in a statement. “Our firm believes there is a new framework of thinking that can be helpful in maneuvering these markets and is designed to address the protection and growth of investment assets.”
The series of white papers is “trying to frame a way in which advisors can position investment solutions,” Scott Sipple, head of global investment strategies, told ThinkAdvisor. Here are the four recommendations in the latest – and first – Putnam report:
1. Invest Outside of Traditional Bond Market Indexes
As central banks, including the Fed, scale back ultralow interest rates, investment strategies linked to popular bond indexes “will be less safe than many people think,” according to the Putnam press release. The Barclays U.S. Aggregate Bond Index, which represents $18 trillion worth of bonds – that’s roughly equal to the GDP of the U.S. – has a relatively long duration, 5.6 years, making it more susceptible to capital losses when interest rates rise, according to Putnam.
The mutual fund firm is “really concerned” that people purchasing fixed income assets to finance their retirement and other long-term goals will have a “significant loss of principal near term” when rates rise, said Sipple.
Putnam suggests that instead of relatively long-duration bonds, advisors, on behalf of their clients, consider high-yield debt, emerging market debt and non-agency residential mortgage-backed securities – all subject to less investment risk if rates rise.
2. Don’t Depend on Money Market Funds
Come mid-October, the federal rules governing money market funds will change, eliminating the assumed guaranteed $1 per share net asset value of funds that do not exclusively hold government securities. Other money market funds will have a floating net share price and may limit redemptions or charge redemption fees during times of increasing volatility, which could increase the odds of a run on those funds if investors fear they won’t be able to get their money out quickly in a crisis, according to the Putnam paper.
As a result, money market funds will no longer be the risk-averse investments that investors have counted on for years. Funds holding just government securities will have low yields, and funds whose share prices could fall below $1 will have more risk.
“Investors may find that their short-term investment vehicles potentially leave them at greater risk they had thought,” according to the Putnam press release. “Yields will be compressed for many years,” said Sipple.
The firm suggests that advisors consider short-duration income strategies – which sit between money market funds and ultra-short bond funds on the risk spectrum.
3. Consider Absolute Return Funds
These funds aim to have steady positive returns with low volatility no matter how the broader financial markets are performing. They include multi-asset funds, which invest in commodities, currencies and derivatives along with stocks and bonds; long/short funds, which, like hedge funds, hope to profit when stock prices rise and when they fall; and market-neutral strategies that are nondirectional, such as long Japan equities and short U.S. equities.
Unfortunately, like hedge funds, these funds can disappoint.
4. Pursue Active Investment Strategies
“Advisors will want to stay committed to an investment plan rather than to try to guess the best time to be in the market, especially during short periods of volatility,” according to the Putnam press release. To that end, the white paper suggests that in a slow-growth environment, such as the current one, advisors use actively managed funds that selectively choose assets.
“In today’s sluggish growth environment in the global economy,” Putnam is focusing on earnings, “which matter most in the determination of stock prices … balance sheet flexibility, market share advantage and superior technology attributes,” according to the white paper. “Such health is not currently in abundance in U.S. or non-U.S. markets — which is another reason why we consider active selection strategies to be so valuable.”
When asked about the costs of the strategies suggested, which, in the case of active management and absolute return tend to be more expensive than passive strategies and can affect performance, Sipple responded, “We have to perform net of fees. Ultimately that’s what the investor gets.”
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