In the April 2009 issue of Financial Advisor magazine there appeared an article entitled "Dodging The Bullet." The point of this article was to interview three advisors who excelled in protecting their clients from the ravages of the 2008 market meltdown. The investment strategies of each advisor were examined to find lessons all advisors could benefit from when navigating future market crises.

Reactions to this article were mixed. Although some advisors took it at face value and presumably benefitted from its lessons, others were more skeptical, questioning the strategies employed by these advisors. The common sentiment among this second group was, "OK, they got their clients out of the market in time, but when did they go back in and how did they know to do so?"
To answer this question, this article follows up with the same three advisors to see how their client portfolios have fared since early 2009 when they were first interviewed.

David Blain
D.L. Blain & Co, LLC
New Bern, N.C.

In the April 2009 article, David Blain of D.L. Blain & Co., LLC in New Bern, N.C., explained that he moved to an underweighting in equities (10% to 15% of portfolios) beginning in October 2007, which helped him contain the losses in his clients' portfolios to 5%-9% between March and November 2008. By December 2008, said Blain, he was back in equities to the tune of 55% across all portfolios. Today, that average is closer to 65%.

I asked Blain to take me through the time line between 2008 and now, and asked what got him back into equities by December 2008.

"Between December 2008 and April-May 2009," he says, "our models suggested an increasing allocation to equities. The market decline in January-February 2009 negated some of that and we underweighted again, but we were back to a fully weighted position by June 1, 2009. So between December 2008 and June 2009, things were very tenuous. We erred on the side of caution with a largely underweighted position, missing the first six to eight weeks of the rebound."

Blain bases his models on research from Ned Davis Research (http://www.ndr.com/invest/public/publichome.action), which keeps him abreast of current and expected economic scenarios and statistics. (Ned Davis Research is an independent financial firm providing unbiased investment research and investment management guidance to global institutional investors). "My process is very quantitative," says Blain. "The three types of Ned Davis research I pay the most attention to are equity valuations, investor sentiment and momentum factors."

Blain doesn't just review this research and make a seat-of-the-pants decision to change investment weightings. He actually pulls selected data points from Ned Davis Research into his own proprietary spreadsheets, which then guide him in decisions to over- or underweight asset allocations. "It's a system that's evolved over 20 years in practice that results not in decisions to be either all in or all out of the market but, rather, gradual changes up or down." And it's the system that has had him overweighting equity positions since June 2009.

What do his spreadsheets tell him about the future? "We are very cautious about equities as we head into summer 2011. It wouldn't surprise me if we entered a bear market sometime in the next year. However, I manage portfolios based on what's actually happening now, and both equities and commodities are still in a nice uptrend."

Eric Seff
Seff Investments
Albuquerque, N.M.

Eric Seff, who practices in Albuquerque, N.M., and who has a long history in banking and investment management, goes by his gut to a large extent. Back in early 2009, Seff explained he'd been having a general foreboding about U.S. equities for some time before the market collapsed in 2008. This foreboding was fed by then-current economic events including high budget deficits, high trade deficits, a declining educational system in this country, a loss by the U.S. of its economic and military leadership position and, of course, the subprime mortgage mess that was well under way by the time the market tanked.

Seff recommended to his clients that they cut their exposure to equities to 6% or less of their entire portfolio. Those clients who took his advice basically broke even, turning in performances of -2.2% to +1.4% over the 12 months ended November 30, 2008.

Seff's clients re-entered the market (i.e., increased equity allocations) in October 2008. While in retrospect Seff thinks this was a bit premature, his clients have certainly benefitted from the re-entry. And by March 2009, Seff said he was about as bullish as he ever gets based on his belief that the economy was beginning to rebound. Today, Seff's bullishness continues, if somewhat diminished, as we enter a presidential election cycle, which is usually positive for the markets.

However, he's dramatically changed his strategy of asset allocation. In the past, he'd relied heavily on Financial Engines' (http://corp.financialengines.com/index.html) Monte Carlo simulation engine to help him allocate client assets according to their risk tolerances and return requirements. "I abandoned that for three reasons," he says. "First, regardless of its sophistication, Financial Engines is based on historical data. Second, I was thinking of expanding asset classes beyond what could easily be accomplished with mutual funds and ETFs. And third, I reasoned that we'd have, in the future, more frequent and severe crises (e.g., external shocks), and I needed a new portfolio structure/strategy to help my clients meet these challenges."

Seff now divides clients' total portfolio into safe assets and risky assets. He and the client together make sure the division both controls the client's risk while also earning him a high enough return for long-term goals. Seff says the split ranges from 20% risky to a high of 70% risky over his entire client base, with the average probably being between 40% and 50%.

Once he determines how the assets should be divided between safe and risky, Seff relies on two sets of models to set the client's ultimate allocations. One model reflects what Seff believes is the most likely future scenario. If clients think this scenario is too pessimistic, he picks the next mostly likely scenario that's more upbeat.

In clients' risky portfolio segments, Seff now employs (in addition to mutual funds and ETFs) investments in commodities, alternatives and real estate supplemented by equities and "risky" fixed-income investments. Safe portfolios contain investments in insured CDs, money market funds and short-term investment grade corporates and munis.

Seff says his current allocation to risky investments in his most-likely-scenario model is 39% to equities, 9% to "risky fixed income," 10% to real estate, 34% to commodities and 8% to alternatives, but these allocations change continuously. "Right now, I continue to be very bullish, but I don't expect it to last more than a year, when we'll hit another crisis of some kind that will affect the market in a big way. If I'm right, the evolving risky asset model will have bigger positions in real estate, commodities, short Treasurys and the dollar and smaller positions in U.S. equities, large-cap equities in general and "risky fixed income."

Bill Bengen
Bengen Financial Services Inc.
El Cajon, Calif.

Bill Bengen of Bengen Financial Services in El Cajon, Calif., took clients to 0% equities between March and October 2008, something he'd never done before. As a result, his clients' portfolios were, on average, down 10%-11% during that period. As of January 2009, client portfolios were 75% cash with the rest in money market funds, gold and Treasury bond funds. "Preservation of capital was key," says Bengen. His plan at the time was to wait until fall 2009 to get back in the market.

So what happened? "I was slow getting back in," says Bengen. "We never got fully invested and are presently invested to the tune of 50% of normal allocations to risky assets. (If a client's allocation to risky assets would normally be 60%, they're now at 30%, and gold is a significant portion of that.)

What's holding him back from becoming more fully invested? "I'd like to see us reach more healthy valuations. On a trailing basis, P-Es are around 24 and I would like to get back in when P-Es are in the teens, which would probably take a market dip of about 20%." In addition, says Bengen, dividend yields are historically low and the "Q ratio" (a measure of under- or overvaluation based on a comparison between a company's stock value and replacement cost) is soaring. "So a lot of indicators are flashing warning signals, but the present flood of liquidity trumps all in the short run, and markets keep rising."

How are clients reacting to Bengen's strategy? "I explain our strategies and performance to clients in weekly e-mails, but some are disappointed we haven't done better the last few years. Nevertheless, most clients trust my judgment, although that may change. If the bull market continues for another year or two, I will lose some clients, but my instincts say it's not time to throw money into stocks."

Continues Bengen, "It's a frustrating period to be investing in. All the lessons I've learned over many years are not carrying the day now. Investors have been through two severe bear markets this decade and a third one could be on its way, which will probably represent a phenomenal buying opportunity."

David J. Drucker is a Principal with Virtual Office News LLC, producer of the Technology Tools for Today Annual Conference and the T3 Newsletter, and a frequent contributor to Financial Advisor.