Here’s Why Fixed Indexed Annuities Should Be Considered As An Alternative To Bonds

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During his recent interview with Tobias, Zach Abraham, who runs Bulwark Capital Management and has a radio show called Know Your Risk Radio, discusses why investors should consider fixed indexed annuities as an alternative to bonds saying:

Zach Abraham: Now, we still use fixed income and we have as more of a tactical type thing, but just not as that consistent part of the portfolio. At the behest of a relative of mine, who was in the insurance industry, who I didn’t want to listen to because he was in the insurance industry, he’s not a finance guy. I started looking at something called the fixed indexed annuity. Now, before everybody turns the podcast off right now, let me explain-

Tobias Carlisle: I’ll have to delete that out.

Zach Abraham: … because it was really … Yeah, well, we have a segment on our radio show called the Dirtiest Word in Investing and it’s annuity. What we’ll start off by saying is really, there’s so much negativity built around the name. I think my natural value inclination made me a little more open to it. What we started finding out when we dug into these products is, A, you could get a fee free version of the product. You could strip off all the extra insurance riders and you were left with this product that was guaranteed against loss that have no management fee and that was giving you literally 50 to 60% of the S&P 500, depending on the product. It was a nine to 10 year contract. You started looking that and running the numbers on it and it looked really attractive. Just think about it, you get a 60% free ride on the S&P 500. In up years, you go up with it. Down yours, you’re guaranteed against loss. When you look at the returns, it literally looks like a stair.

Zach Abraham: Now, again, due to my view on insurance that was enough to pique my interest, but I was completely skeptical of all the information I was reading. I was like, “This is how insurance companies get you, right?” We spent time talking to the actuaries that built it. We spent time, talking to the guys that built some of the different indexing models. We flew to New York, met with guys at J.P. Morgan that built the new volatility adjusted index that they were using inside of a product, spoke to executives and actuaries at Nationwide. That was J.P. Morgan and Nationwide were two companies that we had some contacts in and really doing our due diligence and just sat there and started looking at these products and said, “Look, on a risk-adjusted basis, if we take the typical 60/40 portfolio and we swap out the bonds with one of these products, we’ve done a couple things. A, we’ve just de-risked the portfolio. We’ve got a portfolio that can’t lose money.” Everybody goes, “Yeah, well, insurance companies can go broke.” That’s true, but it’s an interesting thing about the insurance industry is that every single state has an insurance guaranty fund. These products are essentially backed up by the states themselves. Then, you look at the default rates or the amount of these products that have gone under and there’s virtually none.

Zach Abraham: Any time a company faults or a company goes sideways or belly-up, the Insurance Commission steps in and typically negotiates a buyout of the assets, but the purchasing company has to honor the terms of the original contract. We started looking at it, the cost side of it, the safety side of it, check. We got cheaper and we got even more secure. Then, on the performance side of it, we didn’t know that the underlying indexes were going to perform as well as they have, but it’s been a boon. I mean we were hoping to average 4.5 to 5.5% annual returns and that portion of our clients’ portfolio has been up in average 7 to 8 since we started using these in 2011. It took about three years to get comfortable with it. Every time we get return numbers back, I’d kind of sit there and view it like this, like looking through, waiting for the other shoe to drop, even though we … Again, I’m a finance guy, so I was just as jaundiced and negative about these products as probably a lot of people listening to this are.

Zach Abraham: Then, in 2016, a guy who’s a bit of an idol of mine who I had the pretty cool privilege of getting to interview in the last month on our show was Roger Ibbotson. I know, you know who Dr. Ibbotson is. He came out with a research paper in 2016. It was far more articulate than our take on it, but literally, it was a 16 page research paper that highlighted everything we were talking about and how he thought that this would make a great bond replacement or at least supplement to a bond portfolio. That was really vindication for us. The world of finance, I don’t need to tell you this, but a lot of opinions floating around out there. I think one of the biggest things people want to do is catch somebody with their pants down, sit there and prove that somebody’s an idiot and they’re doing stupid things. That comes with managing money, it’s fine, but I’ll listen to these other guys rage about these annuity products. You get two minutes in and I sit there and I go, “They have no clue what they’re talking about, they just don’t.” I know their arguments thoroughly because I-

Tobias Carlisle: You’ve had them.

Zach Abraham: … had them myself. Yeah, I mean I knew the [inaudible 00:47:42]. When I met somebody, when I met an investor that had an annuity, I was licking my chops, just going, “This is cake, they’re horrible,” but it’s been anything but. I’ll make a pretty bold statement, I think in the retail side of investing, you’re going to see somewhere between 80 to 90% of retail clients in the next 10 years and have a product like this in their portfolio with at least a 15 to 20% allocation to it just because on a risk-adjusted basis, they blow bonds out of the water. We got our three-year returns back on one of our most recent products. It has not been our best performer, but it’s been good. We’ve got clients that are up 21% in the last three years in a product that has no fee and no risk. Again, not the most exciting thing to talk about and it’s why we call the dirtiest word in investing, I don’t like to lead with that because I know when you do, anybody in the investment world is immediately going to go, “Oh, okay, you’re an insurance guy.” I’m like, “No, I’m not, I’m really not.” It’s been phenomenal for our clients and it’s really been some saving grace because it’s offset some of the underperformance we’ve had based on the fact that we’re value focused.

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