Francis Sabourin explains that the declining utility of bonds and the emergence of new vol strategies has allowed him to put a third wheel on his clients’ investment bicycle
Each month at WP we offer a slate of articles and content pieces that go deep on a particular topic. This October, we're focusing on volatility offsets in ETFs.
Francis Sabourin likens the old model of investment management to a bicycle. The director of wealth management and portfolio manager at Francis Sabourin Wealth Management of Richardson Wealth explains that whether in a 60/40, 70/30, or 50/50 allocation the traditional mixes of bonds and equities would function as the two wheels of that bike. Equities were the back wheel, powering portfolio appreciation and adding growth. Bonds and fixed income were the front wheel, stabilizing the clients’ ride. The trouble is, for Sabourin, bonds offer less of the diversification benefit and utility that they once did. He’s responded by adding a third wheel to his bicycle.
That wheel, Sabourin notes, is comprised of less traditional sources of income for a portfolio. Those could include higher yielding fixed income products, some advisors may use of covered call option writing strategies which offer a way to derive cash flow from market volatility thanks to the relationship between options premiums and vol. Sabourin explains, however, that this third wheel comes with inherent trade-offs.
“You have to think a bit differently about the fixed income bucket in order to reduce volatility. For example, we will tend to profit off the cycle in fixed income using tools like long-short credit funds. On the equity side there are a lot of ways to increase yields and income with covered call writing products or low-vol products, some with leverage and some not. There are lots of products where people who are hungry for cash flow can get that even if they don’t come with total returns.”
Sabourin compares an index-tracking S&P 500 ETF with an equivalent ETF from the same provider that comes with a covered call option overlay. Both products experienced volatility, he explains, and both experienced the same drawdowns. Over a ten-year span, the covered call strategy had as much volatility in its NAV and came out having underperformed because of capped upside. It did, however, come with better cash flow.
The takeaway for Sabourin is that these products can help provide income, which can contribute to total returns and satisfy some investors’ need for income. However, presenting these products as likely to outperform overall or even in volatile periods because of their options strategies may be less helpful.
“There is no free lunch in finance, it’s just about using the right mix,” Sabourin says.
Despite trade offs inherent in some of these income products, Sabourin still sees them as having a use in portfolios. As more of these products get launched, with ever more specific underlying holdings and overlayed strategies, Sabourin believes there is a greater opportunity to find that appropriate mix that generates income and helps offset volatility.
Income can help with volatility offsets and managing rising inflation, in Sabourin’s view. By mitigating the downside on asset prices via income, these products can offer a behavioural boost to investors. They can also mitigate the impact of inflation on client cashflows.
Sabourin’s third wheel is largely comprised of long-short credit and long-short strategies. He sees those vehicles as capable of offsetting volatility enough to provide appropriate benefit for clients. He notes that his preference towards alternative fixed income and other vol offsets allowed his clients’ portfolios to outperform during the 60/40 bear market of 2022. While still negative during a period when bonds and equities were positively correlated, those more oblique allocations allowed his clients’ to stay above benchmark performance. It’s in achieving those results that Sabourin has managed to retain client trust amid downturns.
“We saw that last April when the tariffs came along. We had almost 17 years of track record and for the last 17 years our three main models, our balanced, our long-term growth, and our dynamic growth had only three years of negative performance. It's about one every five years. We have shown to clients that even if they are with us for the last six months, then don't worry, the model you choose has been performing quite well every year after we had a negative year. But the cost of taking out or withdrawing the market, timing the market is one of the worst strategies, especially if you have a long-term goal.”
