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The Fixed Income Wreckoning

Well, it has finally happened it seems. The era of easy money and massive liquidity may finally be coming to a close. The era of 20% annual returns seeming "normal" in equities may finally be ending. Of IPOs skying. Of "It's different this time" thinking. By that I mean, it seems that markets may be heading back to normal. We may crash and bang our way back to normal, if Cathie Wood's ARKK Innovation ETF is any indication, but toward a more normal we are headed it seems.

Not just pre-covid, 2019 normal. No, I'm talking pre 2009 normal - before anybody outside Wall Street had ever heard of a credit default swap or knew that a Muppet wasn't just a creation of the late great Jim Henson's. Before the Federal Reserve Bank of the United States of America became one of the largest contributors to stock and bond market performance that any of us have ever seen in our lifetimes.

Yes, back to good old price discovery. And earnings. But in that process of normalization, we may have some reversion to the mean price actions to contend with. In stock market returns contending with currently high historic valuations against more highly discounted future cash flows as rate rise. In bond values readjusting to a secular rise in rates both long and short term. And with that process of normalization and reversion, however long it takes, is the risk that the capital markets will not produce the grist for the mill that your clients in the final stages of nest feathering both require and may expect.

The annuity industry, however, has been quietly and consistently innovating while the capital markets enjoyed their salad years. Interest rates are the lifeblood of the insurance and banking industries, and low rates have forced the industry to find new ways to create value while remaining profitable in a headwind filled rate environment. As rates rise, these new innovations should only get even more attractive, but in the meantime, here are three annuity categories to consider adding to the portfolios of clients today to prepare for this new, suddenly challenging environment.


Why Now? Those who require the return potential that only equities can produce, but who also are wary of expecting more out of seemingly stretched US large cap equities, have a range of enticing options with today's RILAs.

Consider how valuable an allocation to a RILA can be for an equity investor who is 5-10 years from retirement, but still needs the growth potential of equities to get to their desired number. The risk/reward on some of these products seems mighty tempting, to wit:

  • Many products offer non-US index choices, such as developed foreign like EAFE, Euro Stoxx 50, or emerging markets like EEM. Some offer 1,2-,3- or 6-year point to point crediting, with some products offering participation rates north of 100%, without a cap, or attractive caps. (In some cases, the participation rate seems high enough to actually offset the lack of a dividend, which may be appealing to those who might otherwise eschew the annuity for the ETF.)

  • But wait, there's more. Not only do these products offer significant growth potential, but they also offer the comfort of a buffer, some offering 20 percent or more for their six-year point to point strategies. That 1-2 punch of ETF like growth potential with a substantial degree of downside protection seems like an awfully good deal today. And perhaps a great sleeve for the second bucket in a time segmentation strategy that may normally be occupied by fixed income.

  • Throw in the sweetener of valuations that are at a 30-40% discount to the S&P 500, (Forward P/E on EAFE is at 15.4, EEM is at 12.5, S&P 500 at over 20) and it may be remiss NOT to consider a RILA in any growth portfolio today.


Why Now? The last time the S&P 500 was trading near Shiller/CAPE levels that it is trading at today (Cyclically Adjusted Price Earnings Ratio developed by Yale professor Robert Shiller), was in 1999, 2000, and 2001. Today, January 7, it is as 39.38. In January 1999, 2000, and 2001, it was at 40.57, 43,77, and 36.98, respectively.

  • No indicator is perfect, but the Shiller/CAPE has been somewhat reliably prescient in its consistency regarding future returns. The S&P 500 Total Return index in the five-year periods beginning 1999, 2000, and 2001 turned $100,000 into $97,000, $89,000, and $102,000, respectively, at year end 2003, 2004, and 2005. Those kinds of performances are not what equity investors in the last 5-10 years of accumulation are looking for. The risk/reward is too lopsided toward risk, particularly if the amounts accumulated are intended to serve as fodder for future retirement income.

  • The most competitive FIA and RILA products today offering a guaranteed lifetime withdrawal benefit can produce, for a 60-year-old couple looking to retire in five years at age 65, a cashflow of at least 6 percent or more of the amount they use to purchase the annuity. $1 million at age 60 can generate a lifetime income covering two lives of no less than $60,000 a year beginning at 65.

  • Let's put that in Bill Bengen style safe withdrawal perspective. To produce $60,000 annually from a 4% "sustainable/safe withdrawal" beginning in five years means that same $1 million used to buy the annuity must grow to $1.5 million in five years. That's a CAGR of 8.45% net of any fees...let's call them 1% - so let's say 9.45% gross CAGR for five years.

  • How likely is it that an investment policy statement for a 60-year-old couple today looking to retire in five years will allow for investments capable of producing almost ten percent a year on average - in an environment of rising rates and 20x forward P/Es on the S&P 500?

  • No, the annuity isn't for everybody, but the capital markets and an AUM approach to income will have a heck of a time matching what the annuity can guarantee. For couples for whom spending money to live their first ten or fifteen go-go years unabated is an important goal, an annuity/GLWB combo should be in the consideration set.


A year ago, you could buy a fixed indexed annuity and perhaps the best S&P 500 caps you might enjoy - in commission-based, non-advisory forms of the product with a five-year surrender charge, was about 3-3.5%. That is pretty low in the limited (25 year) history of fixed indexed annuities, where it is accepted wisdom that a 5% cap on an S&P 500 indexed account is the Mason/Dixon line of product attractiveness. As a result, there were not many takers a year ago.

  • But those few who did buy these products in late December of 2020, and perhaps decided at that time to replace some of their fixed income holdings intended for portfolio ballast, are probably feeling pretty good right now. When they get their annual statement from their issuers, they'll see that they enjoyed interest crediting to the full cap, so call it $3000-$3,500 for every $100,000 they had allocated to this indexed account a year ago.

  • Compare this to what fixed income holders will experience once they open their year-end retirement account and brokerage statements. The LQD - otherwise known as the iShares iBoxx Investment Grade Corporate Bond ETF, lost over 2% in 2021, and is down another 2% in the first week of 2022.

  • That pattern is not likely to change if J. Powell and Company have anything to say about it, and if the economy continues to expand. Rates are still under 2% - and only just starting what could be a multi-year rise. That may not bode well for returns in fixed income funds. There are ways to mitigate this, either remaining extremely short term or buying floating rate funds, but there simply is no panacea in fixed income land.

  • A fixed indexed annuity can be a solid addition to the ballast component of a portfolio. Despite the crediting being linked to an equity index, the returns on a fixed indexed annuity over at least a five-year period, are almost always positive, even if the equity market in that time is down. That's due to the annual reset nature of the products, and the locking in of prior interest crediting.

  • For example, those bad five-year periods that began in 1999 and 2000, where the equity market lost money, still would have produced positive performance in a FIA with an S&P 500 indexed account and annual point to point crediting, since none of the negative years lost money in the FIA, and there were still at least 2 positive years for interest to be credited.

Yes, we are in a new era of normalization. The good news is that the annuity industry has solutions built precisely for these times.

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