Morningstar Advisor - October/November 2013 - (Page 28)
In Practice
Avoiding the Simple Mistakes
It’s easy to get caught up in new or trendy
products. But in many cases, advisors and their
clients can take a pass. Here’s a quick look
at what to do when temptation may get the better
of you.
Alternatives
Don’t Do This: Buy into the hype surrounding
alternative funds. Many are expensive,
unproven and offer no more downside protection
than a traditional bond fund.
Do This: Focus on strategies that diversify client
portfolios or leverage a talented manager’s unique
skills. Above all, keep costs low.
Income-Plus Strategies
Don’t Do This: Get caught up in a singular
quest for yield. Many income-plus strategies
stretch into low-rated, long-duration or
illiquid securities that could get crushed when
investors shed risky assets.
Do This: Focus on risk-adjusted total return instead
of income alone. That exercise will open
investors’ eyes to the type and magnitude of risk
they are assuming.
Structured Products
Don’t Do This: Buy into what can be a fiendishly
complex product. Structured products argue that
traditional investing methods are passé. But in
many cases, investors can get a better risk-reward
payoff with a more plain vanilla option.
Do This: Explain to clients the range of potential
outcomes with a particular investment. That
should enlighten them to the tradeoffs between
different portfolio mixes of stocks and
bonds. They’ll see they can achieve the same
results of the complex structured product without
all the baggage.
28 Morningstar Advisor October/November 2013
Guarantees
Don’t Do This: Overprescribe guaranteed products
such as annuities to wary investors. Many times,
investors wind up paying too much for downside
protection even though a long time horizon
can usually help them ride out market gyrations.
Do This: Use a ladder strategy with high-quality
bonds. While this option isn’t perfect, it should
give clients peace of mind since they will
get a competitive return and their capital back
at the end.
Non-Traded REITs
Don’t Do This: Chase the yields on these products,
which can be pricey and illiquid.
Do This: Opt for a low-cost, diversified portfolio
of dividend-paying stocks from companies
with competitive advantages. And continue to buy
these stocks when their prices get cheap.
Closed-End Funds
Don’t Do This: Most investors don’t need a
juiced-up municipal bond closed-end fund, even if
there is a truly pressing need for income.
Do This: Level with your clients. Expenses reduce
yield basis point for basis point so pinching
pennies is a surefire way to make their money go
farther. From there, duration-management,
sector-rotation, and issue selection should come
into play, albeit within reason.
Tail Protection
Don’t Do This: Overdue it trying to plan for when
disaster strikes. Simpler can be better, especially if
the investor has a long enough time horizon to
shake-off the occasional drawdown.
Do This: If you think markets are going to pull back
significantly, look at the bonds of high-quality
sovereign issuers.
as investing in out-of-the-money put options.
In the right hands and judiciously applied,
tail protection can make some sense by adding
ballast to a portfolio to fortify it against
a shock, however improbable. The problem
is usually one of magnitude, though,
with portfolios awash in long-duration bonds,
precious metals, inverse ETFs, or other
fare designed to pay-off when disaster strikes.
In these cases, simpler is probably better,
especially if the investor has a long
enough time horizon to shake-off the occasional drawdown.
If you think the world, or at least global capital
markets, are going to pieces, chances are
you’ll do fine owning the bonds of high-quality,
sovereign issuers. Remember that bonds
enjoy their safe-haven reputation because
there is greater certainty as to the timing and
magnitude of future cash flows, unlike
stocks and other risk assets. A bar of gold is
undoubtedly a store of value, but that
value isn’t intrinsic, as it doesn’t generate any
cash flows or have commercial applications.
It’s worth what the crowd thinks it is worth.
And while put strategies can be useful in
certain circumstances, mind the price—many
tail-protection strategies cost an arm and a leg,
greatly dimming their appeal. K
Jeffrey Ptak, CFA, is president and chief investment
officer of Morningstar Investment Services.
The opinions expressed herein are those of
Morningstar Investment Services, are as of the date
written and are subject to change without notice,
do not constitute investment advice and are provided
solely for informational purposes and therefore
are not an offer to buy or sell a security; and are not
warranted to be correct, complete or accurate.
Morningstar Investment Services shall not be responsible for any trading decisions, damages, or other loses
resulting from, or related to, the information data,
analyses or opinions or their use.
©2013 Morningstar Investment Services, Inc. All rights
reserved. Morningstar Investment Services, Inc.
is a registered investment advisor and wholly owned
subsidiary of Morningstar, Inc. The Morningstar name
and logo are registered marks of Morningstar, Inc.
Table of Contents for the Digital Edition of Morningstar Advisor - October/November 2013
Morningstar Advisor - October/November 2013
Contents
Contributors
Letter From the Editor
How to Make Social Media Work for You
Do Mutual Funds Still Have a Role?
More Personal Than Finance
How to Handle Your TIPS Positions
A Real Estate Veteran Starts From Scratch
Investments á la Carte
Investment Briefs
When to Say No
Take a Guarded Approach to Homebuilders
Fund Distribution Has Been Turned on Its Head. Now What?
Winning the Distribution Battle
Active ETFs Wait for Their Heyday
A Fund Firm Defies Indexing Trend
Piloting New Channels
A Good Fit
The Predictive Power of Fair Value Estimates
Does Being Prudent Pay Off?
Utilizing Utilities’ Total Return
Stuck in the Middle Is Not a Bad Place to Be
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
The Good Guys Win
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