Last month, I looked at the first two sections of Gregory Curtis's important new book, The Stewardship of Wealth: Successful Private Wealth Management for Investors and Their Advisors. In those introductory sections Curtis argued, convincingly I thought, that open architecture firms will be the winners in the investment management world; the old-school wirehouses and the use of commissions as compensation for financial advisors will disappear in the near future. In this column, I'll take a look at Part III of the book, on investing, which Curtis says is the section most important for financial advisors.

He includes a lengthy and thorough section on how to pick each class of investment, how to allocate them and how to build a solid, diversified portfolio. But what I find interesting is that he places equal emphasis on explaining his thought process-the way he chooses portfolio securities so that clients will understand how each asset class works, why each is included and what the client can expect from it. "The asset allocation selected for a client's portfolio has to be right," Curtis says.

What's important is the way an advisor "frames the issues and discusses the process" with the client. All too often, he writes, "asset allocation strategies seem to the client to have emerged from an incomprehensible black box." The family might implement the strategy anyway, "but that doesn't mean they understand the first thing about it, or why it was selected or how it is likely to perform over time. As a result, the strategy may be abandoned at the first sign of trouble," which is the very worst outcome for a family and an advisor.

"Because the process of understanding a family and its objectives is so crucial, it can take many months and many conversations to get it right," Curtis says. "Advisors who rush into the job of designing a portfolio are likely to find that they have incorrectly understood the family's needs, and/or that the family has misstated those needs," he says.

Curtis goes on to discuss what he considers a superior approach to portfolio building, one that was designed by Fischer Black and Robert Litterman (and is very difficult for many people to understand). He writes that using Black-Litterman to design portfolios "represents a very large advance over older approaches" but that it "isn't for sissies." For a long time after it was introduced and many articles were written about the method, "It was still maddeningly difficult," he writes, "to figure out how to design a real-world portfolio using Black-Litterman techniques." (Thomas M. Idzorek, of Ibbotson Associates has written a paper called A Step-by-Step Guide to the Black-Litterman Model that Curtis recommends to any investor or advisor who wants to "migrate from traditional asset allocation models to a more sophisticated model.")

An advisor can construct a portfolio with the best modern portfolio theory techniques, yet "we know from examining the actual data that some market events-namely very bad portfolio performance-will occur far more often than a normal distribution would lead us to expect, Curtis says. But the real risk that investors face is that they will "depart from our sound strategies in the face of unexpectedly poor results." It's not that high returns are unimportant, Curtis says. "It's that private capital is irreplaceable."

Advisors who have been in the business for a long time may believe that they know the best way to design a portfolio without consulting the family. But Curtis says that "there is no one best way to design an investment portfolio for a family-everything depends on the family itself."

It's important to get the family talking about the nature of the risks it faces with its capital, to ask the right questions and, especially, to listen to the answers.

Suppose a family comes to Curtis-or to you-when they are mostly in cash. How do you move them to the new strategy you've designed? "In cases of uncertainty, my suggestion is to keep firmly in mind how long it took the family to get rich." He takes as an example a client family of his that sold its business, one that had taken it three generations to build. It was 2001 and Curtis wanted to implement the new strategy slowly, investing in the long-term equity portion of their portfolio over three to five years. That wasn't fast enough for the family, who invested $100 million-a fraction of their wealth-in long-term stocks. It did not do so well. But it taught the family about the complexity of risk.

Because Curtis believes most money managers subtract value from a portfolio, he devotes one chapter to the default position of index funds. Even the active managers you use should not be part of the permanent portfolio, he says. Use them when you think the time is right for their style.

But be careful. Many investors are so terrified by the sin of "market timing" that they interpret any sort of tactical positioning as timing the market. This is a mistake, Curtis says, and it's "especially a mistake in family portfolios, which are far more sensitive on the downside than on the upside."

Curtis discusses how to add value with tactical repositioning, opportunist investments, monitoring and rebalancing. He also warns advisors to be careful about what they consider a hot new investment. He recalls that when he sat on the board of a university, one member asked the board's financial advisor if he had any interesting investment ideas. "Well," said the advisor, "I saw in The Wall Street Journal that the smart money is buying blue chips."

Throughout the book, Curtis provides "practice tips" for advisors. Some clients, for instance, are "manager junkies," investors who seem mesmerized by money managers and believe that selecting great managers is the key to investment success. Such clients can be very difficult to deal with, as they are constantly chasing hot managers and insisting that their advisors hire this one or that.
"A cursory look will usually disclose that the manager the client wants to invest with simply happened to be in the right place at the right time recently, and will soon be in the wrong place at the wrong time," he writes.

In these cases, a good strategy is to structure the equity portfolio in a core-and-satellite manner, using a passive, tax-aware core. Around this core you can engage "satellite" managers entrusted with much smaller portions of the portfolio.

"This strategy allows us to honor the client's wishes, even if we are skeptical about the manager," Curtis says. If the client is right and the manager outperforms, the advisor can always boost that manager's share. But in the likely event the manager disappoints, at least he will have done so with less client money.

Curtis says that, historically, real estate has been uncorrelated with the traditional assets in family portfolios, chiefly because it is illiquid. Over a long time period, real estate tends to underperform stocks. Real estate's main advantage is that it tends to move in a different direction from the rest of the market, so it offers good diversification. Also, it acts as a natural hedge against unanticipated inflation. Oil, meanwhile, performs like a sensitive reflector of global fears, Curtis says. Oil prices spike with talk of war or disruptions in the Middle East, whereas other commodities barely move.

Curtis also provides a section on the mistakes bond investors make. He says he's always surprised that, given the efficiency of the bond market, so many bond managers claim that they've outperformed the indices. In almost every case, "outperforming" resulted from adding more risk to the portfolio than what was found in the index, he says. So the bond manager outperformed the index but did not manage risk-adjusted outperformance.

Curtis suggests that given our uncertain world, the fact that the United States has lost its "AAA" status and has no solid plans to reduce its debt load, a financial advisor might consider global diversification even in client cash holdings.

Like manager junkies, a client who is a "hedge fund junkie," makes the advisor's life difficult. This client becomes so excited by the latest hot manager that he has to invest with him. He can never build a "best in class" portfolio because he is always fascinated by the hottest new fund. Soon, the client's portfolio fills up with "very average funds." Curtis suggests that advisors show clients the performance of individual hedge funds, not only after fees but after taxes. "Only the very best hedge fund managers will produce good risk-adjusted performance on an after-tax basis."

The reason money managers subtract value is that their services are overpriced relative to the value they bring. "In the asset classes that matter most to investors-U.S. large- and mid-cap stocks and bonds-most managers will underperform over time by at least an amount equal to their fees and trading costs, to say nothing of taxes," he says.

Curtis ends with an appendix on how to be happy. I won't spoil the surprise.

Mary Rowland can be reached at She has been a business and personal finance journalist for 30 years and has written two books for financial advisors:
Best Practices and In Search of the Perfect Model.