Interest rates are top of mind for advisors. A new survey from Fidelity Financial Advisor Solutions found that in anticipation of the next Federal Open Market Committee meeting in September, “interest-rate fatigue” might be a thing of the past, with many financial advisors trying to address their clients’ concerns about when rates will rise, and by how much.
The focus on interest rates played a role in putting other topics under the spotlight for advisors, with portfolio management, market volatility, fixed income and client guidance – in that order – making up the rest of the top five top-of-mind themes.
“In an uncertain market environment, we’re hearing that advisors would like to receive support in managing their clients’ emotions,” said Scott E. Couto, president of Fidelity Financial Advisor Solutions. “On one hand, advisors are looking to set client expectations on a potential rate hike and the longevity of the bull market in equities; on the other hand, advisors want to help their clients understand the impact of what’s happening in the market on their portfolios.”
While Fed monetary policy tightening could spark increased market volatility and be unsettling for investors, Couto suggests the ups and downs of the market are inevitable and altogether normal. Advisors should bear a few things in mind when discussing asset allocation with their clients:
Three key considerations:
- The first rate hike is not a showstopper – Despite the start of a Fed tightening cycle, equities have historically averaged double-digit gains in the year after the first Fed move. The story is similar with fixed-income. While bonds have averaged a slightly negative performance in the months immediately following a rate hike, advisors can encourage their clients to take a longer view. On average, high-quality bonds have recorded low single-digit gains in the first year after a rate hike. Over two years after the first hike, the average return increases to the double digits. The bottom line: don’t bail out at the first signs of volatility. Many of the best periods to invest in U.S. equities have been those environments that were the most unnerving, and selling an investment because of a drop in value does nothing more than lock in the loss and prevent investors from profiting from any subsequent gains.
- Don’t move into defensive sectors too quickly – Is the first rate hike a sign to move investments toward more defensive sectors? Historically, the first rate hike has taken place during the mid-phase of the business cycle.2 This is a time when the economy is seeing growth, as reflected by strength in corporate earnings. It is also, on average, two years before the late cycle kicks in. When the business cycle does move into the late phase, advisors should encourage their clients to think about investing in utilities, energy, health care, materials and consumer staples – sectors that tend to outperform on a relative basis.
- Remember the role of high-quality bonds – Because of the potential for higher rates, some investors are shifting away from investment-grade debt to unconstrained fixed-income. Advisors should help their clients understand that while this may reduce interest-rate risk, it may also add significant credit risk. Given their low correlation to equities, investment-grade bonds play an important role in a diversified portfolio. A multi-sector “core-plus” fixed-income portfolio – with a high concentration in “core” investment-grade debt and the rest in credit-sensitive “plus” sectors – may help to provide attractive risk-adjusted returns while maintaining downside protection through varying economic conditions.
“Taking the time to look at an individual investor’s portfolio goals, time horizon and tolerance for volatility can help advisors respond in a way that will foster a stronger relationship with their client,” explained Couto. “Market fluctuations occur more often than clients may realize – offering them the historical context and making a plan that helps them diversify and stay fully invested over the long term may help.”
See Also:
- Is Your 401k Plan Ready For Rising Interest Rates?
- Retirement Advisors Fail at Tax-Efficient Investing
- Employees Value “Do-It-For-Me” Approach to 401(k)s
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
