“In many cases, improvement is not about doing more things right, but about doing less things wrong.” – James Clear
Before applying the quote above to our portfolios today, think about this:
There’s nearly 16 Trillion (yes with a T) dollars in negative yielding bonds globally, interest rates are as low as they have ever been, and bonds are as expensive as they’ve ever been. A negative yielding bond…try explaining that to yourself, it makes zero sense.
At the portfolio level, we are continuing to focus on yield and risk management, but how we’ve altered our fixed income (bond) exposure is what we wanted to elaborate on as it’s directly related to the quote above.
We believe bonds will be a drag on returns over the next few years and we’ve adapted portfolios accordingly while maintaining a focus on risk.
Aptus Portfolio Objective
We are seeking sufficient return delivered in a way that can be behaviorally tolerated at the portfolio level. (See the following two articles that elaborate on the previous sentence: Can You Stick to Your Strategy? & The Perfect Portfolio)
We want to generate the returns you need to sustain or even improve you and your family’s quality of life now and into the future. We have the responsibility to use our brains and make sound decisions.
One of the biggest portfolio construction decisions we make is at the asset class level. Most accessible investment opportunities fall into one of the following:
The current 30-year treasury bond is yielding around 1.95%. The US Government is borrowing money for 30 years and the lender (investors) has locked in 1.95% yield. That’s before inflation.
You are losing money in real terms if inflation runs around the targeted 2% rate. Do bonds make sense moving forward? Refresher of bond environment in general:
The traditional portfolio that is 60% stocks and 40% bonds has performed incredibly well over the last 20 years. The default thinking is stocks generate the returns and bonds act as the stabilizer that spits off income. The data doesn’t fit that narrative – look at the chart below with the blue line being stocks and the orange line being bonds. Since 2000 bonds have outpaced stocks in total return.
The advocates of the buy and hold 60/40 portfolio will refer to the combined historical returns, but remember, what has happened matters less than what will happen. You have to build portfolios looking through the windshield, not the rear view mirror. Weighing the evidence, the chances of bonds delivering the types of returns above are not great and here’s why –
The current 10-year treasury bond yields less than 1.50%. As you can see in the chart below, current yield is a decent proxy for the annualized return bond investors can expect over the next 10 years. A very different story than the one told above, and not a promising one!
What’s the risk of having too much bond exposure?
It’s not drawdown risk, or volatility risk…It’s the sneaky kind of risk that you don’t recognize until it’s too late – opportunity cost.
If your goal is to run from point A to point B and you need to average 8-minute miles to get there in time – no matter how far the destination – wearing a 20-pound vest wouldn’t make a lot of sense. You could still run, and you may not notice it at first, but over any distance it is a drag you don’t need.
That’s how we view portfolio construction and our allocation to bonds. Our Defined Risk Strategy has allowed us to own less of an asset class we think will drag returns down moving forward and position the portfolio for higher potential returns.
Defined Risk Strategy
Less bonds in a portfolio does not have to mean more stocks. Over allocating to stocks can create return streams that exhibit too much volatility and potential for drawdown.
With the Aptus Defined Risk Strategy, we created what we see as a hybrid asset class – a strategy designed to limit interest rate exposure and potential for drawdown, but positioned to generate income and offer upside potential in the stock market. Since inception, our Defined Risk strategy has been a compelling alternative for traditional fixed income exposure, see here how it’s acted relative to the S&P 500 Index and Aggregate Bond Market Index (*please see DRSK Standardized Performance Disclosure below)
The historical returns of a 60/40 portfolio should not be extrapolated into the future. Looking at the market backdrop, the math of a traditional 60/40 portfolio is not inspiring. To paraphrase the opening quote – we can improve the math by doing less things wrong. In this case, we are referring to bonds.
There’s not a lot about the current fixed income landscape that makes sense to us, especially when considering the allocation of hard-earned investment dollars with the goal of generating sufficient return.
We’ll be talking about these issues in more detail on an upcoming webinar hosted by ETF Trends. Register here to join us on September 24 at 11am PST / 2pm EST, we’re excited to have a great panel lined up to discuss the challenges and opportunities this rate environment has triggered.
As always, thank you for your trust and don’t hesitate to reach out with any questions.
The Aptus Team
*DRSK Standardized Performance Disclosure
Cumulative return is the aggregate amount that an investment has gained or lost over time. Annualized Return is the average return gained or lost by an investment each year over a given time period. Performance is annualized for periods greater than 1 year.
Performance quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate, so you may have a gain or loss when shares are sold. Current performance may be higher or lower than that quoted. Short-term performance in particular is not a good indication of the fund’s future performance and an investment should not be made solely on returns. Past Performance is not indicative of future results, which may vary.
This information is furnished in order to provide general investment and administrative information. The investment information is general and educational in nature, does not consider other investments that an individual may own, is not a prediction of external economic conditions, nor considers an individual’s past investment experience. Individuals may wish to seek professional investment counsel before making investment decisions. These analyses have been produced using data provided by the investment managers, third parties, and public sources. While the information is believed to be reliable, its accuracy cannot be guaranteed.
As with any investment strategy, there is potential for profit as well as the possibility of loss. Aptus Capital Advisors, LLC does not guarantee any minimum level of investment performance or the success of any portfolio or investment strategy. All investments involve risk and investment recommendations will not always be profitable. Past performance does not guarantee future results.
Aptus Capital Advisors is the advisor to the Aptus Behavioral Momentum ETF, Aptus Fortified Value ETF, Aptus Defined Risk ETF, and Aptus Collared Income Opportunity ETF, all of which are distributed by Quasar Distributors, LLC.
The fund’s investment objectives, risks, charges and expenses must be considered carefully before investing. Important information about the fund and are available at aptusetfs.com or by calling 1- 800-617-0004. Read it carefully before investing. Please click here for the Aptus Defined Risk ETF prospectus.
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