The widespread economic shocks engulfing the developed world for the last two years have had far-reaching effects. Some are known and some as yet unknown. But one thing is for certain – interest rates are at historic lows … still. Low interest rates have varying consequences, but perhaps one unintended consequence of our prolonged low-interest rate environment is the unique challenge it has presented to financial advisors and their investors. Due to the low rates, the cost of borrowing for institutions has decreased dramatically, leaving investors with few places to stash any substantial amount of cash and generate anything resembling a decent positive return. So, the question for independent financial advisors becomes, “What to do?”
I would contend that the limited availability of positive yield has created a more challenging environment for financial professionals than many have given it “credit” for (wink, wink). A brief review of historical interest rates provides an indicator of the extremity of our current situation. In late 2001, in an attempt to climb out of the technology bust and the post-911 economic stagnation, the federal funds rate dipped below 2%. To give some context, that was the first time that the fed funds rate had dipped below 2% for almost 40 years! Since that time, the fed funds target rate has dipped below 2% for half of the past decade, with the current target set as low as you can go (0.00%-0.25%).
However you slice it, our foray into prolonged monetary stimulus is really unprecedented, and it’s been a bear for financial advisors and their clients to deal with. Some of the reasons follow.
In theory, lower interest rates fuel lending and corresponding economic growth. Economic growth should in turn fuel stock prices and overall economic expansion. Unfortunately for financial advisors and their clients, the latter has not occurred in a prolonged, sustainable fashion. As a result, client portfolios have suffered from no yield in money markets, low-yielding bonds, flat decade-to-date returns in stocks and collapsing asset bubbles in real estate. Under these challenging circumstances, a financial advisor may have done well by simply limiting losses and managing tax burdens.
Here again, in theory, investors should really measure advisor performance on a relative basis. So, you ask, if all financial advisors and their investors have faced the same macro challenges, than why is it so hard to be a successful financial advisor in this environment? The answer is that nobody likes flat or negative returns, regardless of how well their performance has been on a “relative basis”. It’s simply human nature that investors want to see positive returns. As ridiculous and illogical as it may sound, many investors would be happier with a 6% yield when the average is 8% than they would be with a -2% yield when the average is -10%. After all, a 6% return is at least positive, right? Great financial advisors know that limiting losses is just as important as increasing gains, but it’s just not nearly as fun to talk about limiting losses with your clients. And with no positive yield coming from the cash components of portfolios, negative overall yields are a reality. Unfortunately, this has been the world that financial advisors have been forced to live in on-and-off for almost a decade now.
In earlier decades, conservative clients could get a 5% return in cd’s, perhaps a little more yield in bonds with some limited exposure to stock gains/losses. Now, that positive return component provided by cash/cd’s/money market funds etc., which has been the safety net of financial advice for decades, has basically vanished.
In order to obtain some positive yielding trends for their clients, many financial advisors have turned to direct investments into income-producing hard assets such as real estate, mortgage lending, equipment leasing and energy programs. While we all know that past performance is not necessarily indicative of future results, these types of investments have traditionally provided current income to investors. The yield component of these investments is probably more attractive in the current environment than ever before. Because of the attractiveness of the current yield, it is more important now than ever to consider the make-up of the income and the overall risk/return profile of the particular investment. All things considered, on a relative basis, direct investments that are yielding 5-8% are clearly outperforming many other asset classes in terms of current income.
But not all direct investments share the same risk profile, and it’s important to focus on the sustainability of the distribution/dividend as well as the real potential for capital appreciation. For any investor seeking yield, the long-term sustainability of the distribution should rank very high in an advisor’s asset allocation decisions. Perhaps more importantly, as the current yield rises, it becomes ever more important to ensure that the current and overall return potential are commensurate with the risk being taken. In many cases, the attractiveness of another 1-2% in the area of current yield simply doesn’t justify the additional risk.
For help in identifying the characteristics of risk/return profiles associated with the various products on our platform, please contact the Direct Investments group in the Centaurus Home Office and we can provide you with additional resources to help in your review of our available products. While the initial due diligence of any new product can be painstaking, it’s always worth the effort and, in the end, bolsters your expertise. With a little work, we hope we can help you find some of those elusive positive returns that make for “happy” clients.
Centaurus Financial is an independent broker/dealer, Member SIPC, and a registered investment advisor. If you are choosing a financial advisor, please contact our home office at (714) 456-1790 or send an email to contactus@cfiemail.com. Our home office team will pair you with a top broker or one of the best financial advisors available to meet your needs. More comprehensive information is available at our recruiting website: www.joincfi.com.
Financial Advisors Hunting Yield in 2010
The widespread economic shocks engulfing the developed world for the last two years have had far-reaching effects. Some are known and some as yet unknown. But one thing is for certain – interest rates are at historic lows … still. Low interest rates have varying consequences, but perhaps one unintended consequence of our prolonged low-interest rate environment is the unique challenge it has presented to financial advisors and their investors. Due to the low rates, the cost of borrowing for institutions has decreased dramatically, leaving investors with few places to stash any substantial amount of cash and generate anything resembling a decent positive return. So, the question for independent financial advisors becomes, “What to do?”
I would contend that the limited availability of positive yield has created a more challenging environment for financial professionals than many have given it “credit” for (wink, wink). A brief review of historical interest rates provides an indicator of the extremity of our current situation. In late 2001, in an attempt to climb out of the technology bust and the post-911 economic stagnation, the federal funds rate dipped below 2%. To give some context, that was the first time that the fed funds rate had dipped below 2% for almost 40 years! Since that time, the fed funds target rate has dipped below 2% for half of the past decade, with the current target set as low as you can go (0.00%-0.25%).
http://www.moneycafe.com/library/ratecharts/ratecharts2.gif
However you slice it, our foray into prolonged monetary stimulus is really unprecedented, and it’s been a bear for financial advisors and their clients to deal with. Some of the reasons follow.
In theory, lower interest rates fuel lending and corresponding economic growth. Economic growth should in turn fuel stock prices and overall economic expansion. Unfortunately for financial advisors and their clients, the latter has not occurred in a prolonged, sustainable fashion. As a result, client portfolios have suffered from no yield in money markets, low-yielding bonds, flat decade-to-date returns in stocks and collapsing asset bubbles in real estate. Under these challenging circumstances, a financial advisor may have done well by simply limiting losses and managing tax burdens.
Here again, in theory, investors should really measure advisor performance on a relative basis. So, you ask, if all financial advisors and their investors have faced the same macro challenges, than why is it so hard to be a successful financial advisor in this environment? The answer is that nobody likes flat or negative returns, regardless of how well their performance has been on a “relative basis”. It’s simply human nature that investors want to see positive returns. As ridiculous and illogical as it may sound, many investors would be happier with a 6% yield when the average is 8% than they would be with a -2% yield when the average is -10%. After all, a 6% return is at least positive, right? Great financial advisors know that limiting losses is just as important as increasing gains, but it’s just not nearly as fun to talk about limiting losses with your clients. And with no positive yield coming from the cash components of portfolios, negative overall yields are a reality. Unfortunately, this has been the world that financial advisors have been forced to live in on-and-off for almost a decade now.
In earlier decades, conservative clients could get a 5% return in cd’s, perhaps a little more yield in bonds with some limited exposure to stock gains/losses. Now, that positive return component provided by cash/cd’s/money market funds etc., which has been the safety net of financial advice for decades, has basically vanished.
In order to obtain some positive yielding trends for their clients, many financial advisors have turned to direct investments into income-producing hard assets such as real estate, mortgage lending, equipment leasing and energy programs. While we all know that past performance is not necessarily indicative of future results, these types of investments have traditionally provided current income to investors. The yield component of these investments is probably more attractive in the current environment than ever before. Because of the attractiveness of the current yield, it is more important now than ever to consider the make-up of the income and the overall risk/return profile of the particular investment. All things considered, on a relative basis, direct investments that are yielding 5-8% are clearly outperforming many other asset classes in terms of current income.
But not all direct investments share the same risk profile, and it’s important to focus on the sustainability of the distribution/dividend as well as the real potential for capital appreciation. For any investor seeking yield, the long-term sustainability of the distribution should rank very high in an advisor’s asset allocation decisions. Perhaps more importantly, as the current yield rises, it becomes ever more important to ensure that the current and overall return potential are commensurate with the risk being taken. In many cases, the attractiveness of another 1-2% in the area of current yield simply doesn’t justify the additional risk.
For help in identifying the characteristics of risk/return profiles associated with the various products on our platform, please contact the Direct Investments group in the Centaurus Home Office and we can provide you with additional resources to help in your review of our available products. While the initial due diligence of any new product can be painstaking, it’s always worth the effort and, in the end, bolsters your expertise. With a little work, we hope we can help you find some of those elusive positive returns that make for “happy” clients.
Centaurus Financial is an independent broker/dealer, Member SIPC, and a registered investment advisor. If you are choosing a financial advisor, please contact our home office at (714) 456-1790 or send an email to contactus@cfiemail.com. Our home office team will pair you with a top broker or one of the best financial advisors available to meet your needs. More comprehensive information is available at our recruiting website: www.joincfi.com.