Bonds aren't providing much of a cushion lately
Fears over rising interest rates in the U.S. have eroded the value of bonds, raising worries about portfolio diversification.
U.S. stocks have kept chugging higher this year, but bonds haven't been able to shake off a five-year slump. That has sent some investors interested in a diversified portfolio searching for alternatives.
To be sure, investors today are receiving higher coupon payments on newly issued bonds than they have in decades. But persistently rising yields have put pressure on prices of older bonds, leading to weaker total returns.
Although the math in the bond market is starting to shift in favor of buying, investors interested in building diversified portfolios now have plenty of other options. Given that the Federal Reserve is expected to continue raising interest rates, which could heap additional pressure on bonds in the near term, it may be worth exploring some alternatives.
Managed futures
An asset that offers true diversification should perform well when stocks are struggling. While stocks and bonds struggled in 2022, many exchange-traded funds focused on managed-futures strategies did quite well.
For example, the iMGP DBi Managed Futures Strategy ETF DBMF, one of the largest such funds, rose 12.8% in 2022, according to FactSet data, while the S&P 500 SPX tallied its worst calendar-year performance since 2008.
Todd Sohn, chief ETF strategist at Baird Strategas, pitched managed futures as a possible bond replacement in a report shared with MarketWatch. He said the strategy offers relatively low correlation to both long-dated bonds and stocks.
Managed-futures ETFs are modeled after commodity trading advisers, a type of hedge fund that generally trades futures contracts across commodities, currencies and financial assets including fixed income and equities. They may take both long and short positions, making bets on rising or falling prices in markets.
While September has been bumpy for equities and fixed income - with the Dow Jones Industrial Average DJIA and the broad U.S. investment-grade bond market both down month to date - many funds targeting managed strategies have outperformed.
"It's another strategy that's trying not to look like your traditional stocks and bonds," said Drew Pettit, chief investment strategist at Roundhill Investments, when asked about managed futures.
Equity-derivative income
Given how strong performance has been in the stock market over the past decade, it's understandable that investors sitting on paper losses in their bond portfolios this year might wish they had more exposure to stocks.
So-called equity-derivative income ETFs have seen their popularity take off these past few years, becoming a popular niche in the rapidly growing world of actively managed ETFs. Based on a strategy once only available to wealthier investors, these ETFs offer an attractive design feature: You get some equity exposure, while also collecting regular income.
Investors looking for yield are increasingly turning to derivative strategies, like covered-call writing on stocks, to generate income, said Scott Chronert, managing director and head of U.S. equity strategy at Citi Research, in a phone interview.
Derivative-based strategies designed to provide income have proliferated in the ETF market - from autocallable funds that use swaps, to covered-call strategies involving options.
The JPMorgan Equity Premium Income ETF JEPI is the largest ETF focused on equity-derivative income, according to Aniket Ullal, head of ETF research and analytics at CFRA Research.
Gold and bitcoin
Demand for gold (GC00) and cryptocurrencies is bouncing back as investors hunt for diversification - though flows remain "well short of prior extremes," according to a recent report from Strategas.
The two assets remain classic alternatives for investors looking for exposure outside of stocks and bonds, although investors hoping that gold might offset losses in their stock portfolios might be disappointed.
To the thinking of Vance Howard, CEO and portfolio manager at Howard Capital Management, gold and bitcoin (BTCUSD) can help investors hedge against waning trust in the traditional financial system as the U.S. enters an era of potentially unsustainable deficit spending. Gold and bitcoin have both shined as diversifiers recently as bond yields BX:TMUBMUSD10Y have pushed higher.
Howard said he holds modest exposure to crypto and gold via the iShares Bitcoin Trust ETF IBIT and the SPDR Gold Shares GLD ETF, of around 3% each.
Investors have been adding capital to each of those funds lately. The iShares Bitcoin Trust ETF has taken in about $2.7 billion of inflows over the past month through Wednesday, while SPDR Gold Shares has attracted about $1.4 billion over the same period, according to FactSet data.
-Christine Idzelis
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