2020 has been unprecedented in more ways than one. Amid a global pandemic and a highly charged political landscape, it’s almost impossible to anticipate what is around the corner.
To navigate this uncertainty, advisors are working to build a shield that can help protect client portfolios against unexpected risks. However, risk management is unfortunately no easy task in today’s investment landscape.
Just 20 years ago, a hefty bond allocation would have been a no-brainer for any investor looking to mitigate risk in their portfolio. But with the 10-year Treasury currently yielding less than 70 basis points, fixed income is no longer an attractive option for many investors who are seeking a consistent source of income that will help sustain their lifestyle.
This poses a unique challenge for advisors: finding a risk management solution that helps protect against downturns, but also allows for participation in the upside potential of equity markets.
In an ideal world, there would be one perfect risk management solution to meet every investor’s needs, but the truth is risk management cannot take a one-size-fits-all approach. To help understand the options available and how to determine the best solution for your clients, let’s dive into how risk management has evolved in recent decades and the benefits of each strategy for investors.
A common risk management strategy for investors has historically been the balanced portfolio — a 60% equities/40% fixed income asset allocation. In the 1980s and 1990s, this asset allocation worked quite well for investors, particularly near-retirees seeking low volatility and a steady source of income.
However, with bond yields at historic lows, many argue that a 40% allocation to bonds will no longer provide the income many investors need. The Federal Reserve’s unprecedented monetary policy and stimulus support in 2020 has effectively upended traditional notions of a balanced portfolio of 60% stocks and 40% bonds.
In the early 2000s, structured notes began gaining traction as a customizable way to meet an investor’s specific risk/return objectives using derivatives. These hybrid financial instruments offered investors diversification, downside protection and exposure to new, traditionally hard-to-access markets.
However, investing in structured notes comes with its own set of risks. Structured notes have an inherent layer of credit risk and are extremely illiquid, so are not suitable for every investor.
Fixed Indexed and Indexed Variable Annuities
Fixed indexed annuities (FIAs) and indexed variable annuities (IVAs) are popular solutions for investors nearing retirement who are looking to mitigate longevity risk and other obstacles associated with retirement income. Social Security may no longer be a sufficient source of income for retirees, so FIAs and IVAs offer retirees and other investors long-term growth potential plus a level of protection.
These annuities are also backed by the issuing insurance companies, providing investors with additional guarantees in their sources of retirement income.
Buffered Outcome ETFs
As part of the latest evolution in risk management, buffered outcome ETFs leverage the liquidity and transparency of the ETF wrapper, while offering a level of risk mitigation and the opportunity to participate in the upside potential of equity markets.
While these products can have a higher expense ratio, they can help reduce market correlation and improve risk-adjusted returns — an important factor for investors as they face unprecedented market volatility. In addition, ETFs offer flexibility and can be incorporated into an investor’s portfolio in a variety of ways, from managing risk in an equity allocation to diversifying a balanced equity/fixed income portfolio. Keep in mind, ETFs involve risk including the possible loss of principal.
The risk management landscape has evolved significantly over the past few decades, requiring advisors and their clients to think differently about how to manage risk in their financial assets. At the end of the day, it’s essential to remember that risk management is not binary. 2020 has proven the future is uncertain and advisors need to be ready to explore new options and adapt their approach to managing risk to help their clients prepare for long-term financial security.
Corey Walther is the President at Allianz Life Financial Services LLC. He is responsible for the business results, strategic direction, sales execution and distribution for several Allianz Life Insurance Company (Allianz Life) product lines — including variable annuities, indexed variable annuities, fixed indexed annuities and buffered outcome ETFs — into multiple distribution channels.