Depending on your client’s needs discovered during the case-design process, index options are available for a host of income, growth and protection strategies. And since market conditions can change on a dime, it may be important to consider indexes with risk controls to reduce volatility, and those with monthly rebalancing and reallocation features. If diversification is important to clients there are index options and strategies to solve that need, too.
In recent years, investing themes that track strategies such as value investing, diversification or research-based approaches have all become available. Here’s a brief look at four features available in FIA index options: monthly rebalancing and reallocation, diversification, risk controls to reduce volatility, and investment theme. Several of the newer indexes introduced in recent years generally include some of these features.
Monthly rebalancing and reallocation. Popular stock indexes like the Dow Jones Industrial Average and Standard & Poor’s 500 periodically rebalance their benchmarks to reflect changes in market capitalization. Most indexes available with FIAs also rebalance, but do so because of price movement or momentum in select stocks, asset classes or market sectors.
Each month, for example, the J.P. Morgan MOZAIC II℠ Index measures the six-month returns of its 15 available asset classes (they include, U.S., British, German, Japanese, and commodity asset classes) then selects nine with the greatest returns during the past six months. Each asset class is then strategically weighted to provide more stable returns.
Every 12 months, the Merrill Lynch RPM Index™ evaluates and rebalances its six global asset classes (domestic, international and emerging markets equities, gold and real estate ETFs, and Treasury bond index futures) based on risk correlation and momentum. Asset classes that have become highly correlated receive lower allocations, while those with negative price momentum are replaced with two-year Treasury notes to smooth long-term returns.
Diversification. The Morgan Stanley Dynamic Balance Index (MSDB) is another option that offers exposure to several major asset classes. They include alternatives like gold and real estate, 10-year and long-dated U.S. Treasuries, investment-grade corporate and high-yield bonds, and U.S., developed market and emerging market equities.
Risk controls to reduce volatility. Similar to MOZAIC and RPM, the MSDB applies objective rules to adjust its allocations among asset classes for diversification but also to manage volatility – the amount of uncertainty or risk from market fluctuations or changes in market performance. It can allocate cash in certain market environments as well as managing to a targeted volatility to smooth out the index’s performance. Other indexes like the RPM also apply daily risk controls to minimize the up and down movements in the asset classes.
Themes. Value investing is a strategy that seeks to buy low-priced assets and sell when the price is high. An FIA option that employs this principle is the Shiller Barclays CAPE® US Sector Risk Controlled 10% USD Total Return Index.
It features a methodology developed by Robert Shiller, the award-winning economist. The index uses the Relative CAPE Indicator that’s based on the Cyclically Adjusted Price Earnings (CAPE) Ratio to identify undervalued market sectors. The indicator evaluates 10 market sectors each month and then identifies the five most undervalued sectors with the greatest 12-month momentum to generate consistent returns.
The sector with the least momentum is identified so as not to invest in a sector that may be undervalued for fundamental reasons. The index equally allocates to the four remaining sectors with the best value and strongest momentum.
Behavioral finance research is incorporated into the NYSE Zebra Edge Index. Based on economic research by Roger Ibbotson, a renowned economist, the index presents an opportunity to benefit from unpopular stocks.
The selection process analyzes the popularity and volatility of the 500 largest publicly traded companies in the U.S. and removes the most overpriced and frequently traded, or those that posted the highest three-month and one-year volatility. The index then selects approximately 200 equities every three months to provide a diversified opportunity to achieve higher return with less risk.
*Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for an investor’s portfolio. All investment strategies have the potential for profit or loss.
Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. There are no assurances that an investor’s portfolio will match or outperform any particular benchmark. Index returns do not represent the performance of the investment adviser or any of the firm’s advisory clients.
**Guarantees and protections of fixed indexed annuities are subject to the claims-paying ability of the issuing insurance company. Fixed indexed annuities are contracts purchased from a life insurance company. They are designed for long-term retirement goals, and also intended for someone with sufficient cash and liquid assets for living expenses and unexpected financial emergencies, including, for example, medical expenses. Depending on the product, fixed indexed annuities may include surrender charges, rider charges and other fees.
***A fixed indexed annuity is not a registered security or stock market investment. As such, it does not directly participate in any stock, equity or bond investments, or index. Gains on indexed accounts are based on participation rates and other conditions offered by the issuing insurance company. Withdrawals are subject to income tax, and withdrawals before age 59½ may be subject to a 10% early withdrawal federal tax penalty.
This document is for informational purposes only and is not intended to provide any recommendations or tax or legal advice. We encourage you to discuss your tax and legal needs with a qualified tax and/or legal professional.
For Financial Professional Use Only – Not For Use With The General Public. 10/18