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.