Some seven in 10 financial advisors in a new poll say it will take a significant equity market correction for investors in general to recognize the benefits of fixed income, Incapital LLC, a fixed income securities underwriter and distributor, reported this week.

However, advisors are not waiting for this to happen. Half of the survey participants said they expected their clients to increase allocations to fixed income or cash over the next 12 months, while only 29% said they expected an increase in equities.

This comes as 76% of advisors say principal protection has become a top priority for their clients.

These were the average asset allocations among the clients served by the advisors surveyed:

  • Equities: 46%
  • Fixed income: 27%
  • Cash: 14%
  • Alternatives: 9%
  • Other: 4%

“With prolonged low interest rates and the sustained equity bull market, investors seeking income might have become comfortable taking on equity risk to accomplish income needs,” Paul Mottola, head of capital markets at Incapital, said in a statement. “That may explain why advisors say it will take a significant correction in the equity markets for investors to appreciate the benefits of fixed income.”

(Related: Morningstar’s Toolkit to Ease Market Downturn)

Mottola said that with increased market volatility, investors will now be much more receptive to assessing some of the potential benefits that are typically associated with fixed income, such as portfolio diversification and lower volatility.

“This is especially true among investors who have taken equity risk for income, and those who now may be focused on principal protection and a fixed and predictable stream of income,” he said.

Q8 Research polled 200 financial advisors across channels from Sept. 20 to Oct.1, using a quantitative online survey methodology.

What Advisors Want

Fifty-three percent of surveyed said providing clients with a predictable rate of income was the main benefit they seek from fixed income investing. Fifty-one percent said it was portfolio diversification, and 38% said it was principal at maturity.

Advisors were particularly bullish on bond ladders, with 80% claiming that these were highly effective in helping investors manage interest rate risk.

Risk of rising rates was the advisors’ top concern with fixed income investing, followed by finding good fixed income solutions in a low rate environment and generating income without increasing portfolio risk.

Given the fundamental benefits sought by advisors, 64% said bond ETFs had changed the definition of fixed income investing away from predictable income and return of principal to fixed income exposure.

“Despite having single security market and credit risk, the features that bonds provide are particularly appealing right now,” Mottola said. “Bonds offer predictable income and return of principal at maturity (absent issuer defaults), if bought at par, and the potential for portfolio diversification which may improve clients’ risk-adjusted returns.

“Most bond ETFs provide many important benefits, such as portfolio diversification and market liquidity. However, their income is generally not fixed, and in many cases their interest rate sensitivity remains constant over time, unlike a bond, which declines over time as the maturity date grows closer. This is an important consideration, especially given the risk of rising interest rates.”

Generating Income

Fifty-one percent of advisors in the survey said they used dividend-paying stocks to generate income in their clients’ portfolios, and used individual bonds only 38% of the time.

Forty-three percent used equity income mutual funds, 43% annuities, 39% bond mutual funds and 29% bond ETFs.

Asked what would prompt them to use more individual bonds in their clients’ portfolios, 38% pointed to a rate increase.

However, 32% also cited a simplified process to access bonds would likely get them to increase their use of individual bonds, 28% said access to better online tools for evaluating bonds and 24% more/better education on bond investing.

“With equity market volatility increasing more recently, it has become critical for advisors to review clients’ portfolios, recognize the inherent risks associated with certain equity income securities and consider the diversification benefits of traditional fixed income securities,” Mottola said.

In a final note, Incapital reported that 63% of advisors in the survey believed that the bull market in bond was over, or would be with 12 months.

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