From yield-generating options trades to funds packaged with bank loans, this is shaping up to be a bumper year for strategies that aim to bring the advantages of professional investing to the masses.
Financial institutions of all kinds are pitching creative trades to clients troubled by uncertainty about the economy and Federal Reserve policy, but virtually no allocation is as profitable as the simplest route: buying and holding the S&P 500.
Asset managers have been pumping money lavishly into a variety of diversification strategies, but they have watched as well-known indexes smashed three of four exchange-traded funds over the past year, their worst loss since at least 2010. Mutual fund firms’ favorite stocks trailed their least favorites, resulting in their worst half-year results in years.
“In a low-volatility, high-return environment like 2024, investors should stick to the basics: buy uncomplicated index funds and active mutual funds with a proven track record of generating alpha,” said Julian Emanuel, chief equity, derivatives and quantitative strategist at Evercore ISI. “Strategies don’t need to be complicated. There’s beauty in simplicity.”
Those who dare deviate from the market-cap-weighted hegemony of the largest indexes have been crushed again and again, thanks to the surges of the likes of Nvidia and Microsoft. For right-leaning investors, this is a boon. The S&P 500 is up about 15%, but it’s only June. The world’s most closely watched stock index has hit its 31st high of 2024 and has risen in eight of the past nine weeks.
The casualty of the concentrated rally has been diversification. Bonds as an asset class have been falling since the start of the year. Materials tracked by the Bloomberg Commodity Index are up just 3%. Just 23% of equity ETFs have been able to beat the S&P 500, according to an analysis by Bloomberg Intelligence’s Athanasios Psarofagis. Actively managed ETFs, quant-driven smart beta and thematic performance-seeking strategies are among the weakest in relative performance.
The relentless rise of indexes like the S&P 500 and Nasdaq 100 has lined the pockets of buy-and-hold investors, but analysts remain wary of a volatile market where Nvidia alone has accounted for more than 30% of the index’s gains this year. After achieving the once-unthinkable title of the world’s most valuable company, the AI chipmaker fell about 7% in the final two trading sessions last week on above-average volume.
“Diversifying and de-risking is the right thing to do heading into the second half of the year,” said Michael O’Rourke, chief market strategist at Jones Trading. “Investors shouldn’t look to Nvidia to continue to almost singlehandedly drive the strength of the S&P 500.”
The rapid expansion of ETFs that go beyond traditional diversification strategies and combine cash flows from selling options with investments in stocks or stock indexes has significantly underperformed their benchmarks, even when factoring in high-yield dividends.The largest ETF, JPMorgan’s Equity Premium Income ETF (ticker JEPI), has earned about 6% on a total return basis.Putting money into cash also represents a big opportunity cost for defensive investors.
The urge to find alternatives to the S&P 500 is being fueled not only by the index’s rapid rise, but also by economic and financial conditions that are difficult to interpret.
Just six months after betting on up to six interest rate cuts by the Federal Reserve, traders were forced to surrender again this week about future monetary easing. Data showed that U.S. services activity expanded by the most in more than two years. Industrial production also rose.
Amid the uncertainty, investors are clinging to tech stocks, which have been a success so far: 41% of fund managers surveyed by Bank of America expect large growth stocks to continue to drive stock market gains.
With muscle memory built up over more than a decade, these money managers have every reason to jump on companies with momentum that promises big revenue growth. But in the process, the more complex trading promoted by Wall Streeters is struggling to satisfy many traders who value safety and diversification.
“The concept of ‘defense’ has changed for many investors,” said Kevin Gordon, senior investment strategist at Charles Schwab. “In this particular cycle, investors’ knee-jerk reaction is to jump into large growth sectors, especially tech companies, as fears start to creep in.”
