An alternative bond strategy that contains no bonds

“The best hedge of a stock portfolio is something that by design moves in the opposite direction of the stock market,” says Sungarden's Isbitts

Dec 30, 2013 @ 11:11 am

By Jeff Benjamin

+ Zoom

At the dawn of a cycle of rising interest rates, some of the efforts to help financial advisers and investors move beyond the tired old fixed-income allocations of the past are refreshing.

The latest example comes from Robert Isbitts, founder and chief investment strategist at Sungarden Investment Research.

Among a handful of separate-account models at the two-year-old firm is something called the cash-flow-focused strategy, which is essentially a marriage of dividend equity and long-short investing.

By now, income-seeking investors should know that the ground is shifting and asset allocation models based on historical bond performance won't likely work.

While it might be OK to make equity allocations based on historic market returns over multiple cycles, such applications for the bond side of a portfolio could leave income-seeking investors wildly unprepared.

“It used to be that your bonds would balance your stocks, but in an era of rising rates, we can no longer count on that,” Mr. Isbitts said. “The best hedge of a stock portfolio is something that by design moves in the opposite direction of the stock market.”

In other words, you might not need bonds at all for a modern-day bond allocation.

On the surface, the Sungarden cash-flow-focused strategy is relatively straightforward.

The first of three components includes dividend stocks that are yielding a least 1 percentage point above that of the S&P 500, which is currently yielding about 2%.

“The overriding goal of the portfolio is for the total yield to be 3 percentage points over the yield of the S&P,” Mr. Isbitts explained.

That is essentially the long side of the portfolio. It will hold up to 20 stocks, and positions will be either full or half, representing either 4% or 2% of the strategy. But the strategy is extremely flexible, and the total equity allocation could range from 80% to as low as 10%, depending on the outlook and broader market analysis.

The second piece of the strategy is the hedge.

Mr. Isbitts uses broad-market-inverse exchange-traded funds for the short side of the strategy, which typically is a 20% short position.

The ultimate objective is to provide low-volatility income that looks and feels like historic bond allocations.

“In general, we have found that our equities will run somewhere in the 80-to-85 beta range if we're fully invested,” he said. “But by being fully hedged, our beta can get down to around 50.”

Mr. Isbitts said the strategy's target beta, or percentage of the S&P's volatility, is at 50, but that he recognizes a “beta comfort zone” of between 35 and 65.

The third component of the strategy is what he describes as diversifiers or “smoothers,” which include some bank loan and master limited partnership ETFs.

“We call it a smoother component because we are buying things that have a much lower beta, but this component is not a requirement of the strategy,” he said. “It's all part of the process of getting the beta to add up to where you want it to be.”

And therein lies the key to the strategy. Like a bond allocation, it is less about the performance than it is about reducing risk.

“It's always about a risk-return tradeoff, and that's how we target the total market exposure,” he said. “The question we ask ourselves all the time is: Will the market's next 10% move be up or down?”


What do you think?

View comments

Recommended for you

Featured video


Ed Slott: The conversation advisers need to have with spousal IRA beneficiaries

Clients who inherit IRAs from their spouses need to decide whether to remain beneficiaries or do spousal rollovers. One important factor in that decision is their age, according to Ed Slott, founder of Ed Slott's Elite IRA Advisor Group.

Latest news & opinion

7 ways advisers fixed clients' biggest financial dilemmas

Sometimes it takes creativity, along with knowledge and outside help, to get a client out of a jam.

LPL Financial buys NPH, a broker-dealer network with 3,200 advisers

The deal, part of which is based on the advisers and revenue that eventually will move from NPH, could potentially cost LPL $448 million.

3 things advisers should make sure their clients' children take to college

Advisers can help clients avoid scary and painful situations with kids age 18 and older.

Private equity investors zero in on the RIA business

P-E proves to be ready and willing to invest in RIAs, but many will be looking to sell in three to seven years.

North Korea: How should advisers react?

Saber rattling is cause for concern, but advisers are not making wholesale moves in client portfolios.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print