Getting downside protection without using fixed income
Aside from fixed-income instruments, what other investments do advisers use to provide downside protection within their clients’ portfolios?
“I am always looking for investments that can provide growth and that have low correlation to both the stock and bond markets,” said Robert Pagliarini, a CFP, author of books about financial planning and the president of Pacifica Wealth Advisors in Mission Viejo, California. “While traditional bonds may provide some downside protection during a prolonged stock market decline, I think bonds at these levels may be risky themselves."
Pagliarini recommends that clients use long/short stock funds; real estate, both directly owned and otherwise; direct lending; and real estate trust deeds, among other assets.
Clients should consider using short-term structured notes that offer about 40% downside protection on the S&P 500 and Russell 2000 and about 7% annual yield, said Dean Catino, a CFP and the president and co-founder of Monument Wealth Management in in Alexandria, Virginia. “The return distribution is very competitive and the downside protection is substantial."
Some non-traditional asset classes such as structured credit, reinsurance and alternative lending have become available in interval funds, which are slowly gaining popularity, said Mark Paccione, a CFP and the director of investment Research at CAPTRUST in Raleigh, North Carolina.
For distinct protection against stock market declines, investors can use exchange-listed SPY options.
“Investors can purchase put spreads where one buys a put with a higher strike price and sells a put expiring at the same time with a low strike price for protection, albeit limited, often at a much lower cost than just buying the same downside put only with no corresponding sale,” Paccione said.
Buying options can be costly, but current premiums remain relatively inexpensive, given low overall volatility levels, said Michael Stritch, senior vice president and national head of investments in the U.S. at BMO Private Bank in Chicago.
“In addition, some alternative investments can be used as protection against market declines by providing a return that is not significantly influenced by the direction of stock movements,” Stritch he said. “Long-short funds or reinsurance strategies would be examples of more non-correlated approaches.”
Rosa Ybarra, a CFP and senior financial planner at Tranquility Financial Planning in McAllen, Texas, views leveraged exchange-traded funds as less risky and more cost efficient than a traditional options strategy to provide protection during market downturns.
“This would be a short-term strategy that we employ to help our client accounts weather the storm,” she said.
This story is part of a 30-30 series on building a better portfolio.