One way is to carve out a portion of a portfolio, say 10%, and devote it to short-term trading strategies or maneuvers. In this way, the long-term integrity of a client's diversified asset allocation schema is not interrupted, and a manageable amount of portfolio assets are kept liquid to make tactical shifts within a reasonable capital gain/loss budget. While many advisors want to put a tactical overlay on a client's entire asset allocation, the reality is that overlays are largely ineffective because of the liquidity constraints arising from alternative investments. The third-party manager relationships, meanwhile, can make it prohibitive to sell without cutting off future access or compromising the investment thesis.
A tactical portfolio carve-out, on the other hand, could be managed in concert with your client, with transactional tools such as ETFs or other highly liquid investments. Then, at regular intervals, economic and market expectations could be reviewed and parameters for a fair value market trading range established. When markets exceed that range, you can sell off and bank profits and still have dry powder at the ready for a market downturn. If the markets dip below that range, you can make new investments or amplify existing ones to take advantage of the dislocation. This allocation could also be used to express a short-term theme or arbitrage opportunity without disrupting the long-term asset allocation program.
Expect The Unexpected
Finally, it must be said that while investment advisors and clients cannot manage portfolios in perpetual fear of financial calamity, they must expect the unexpected, and have the freedom to change course, or not, as judgment warrants. It sounds simple and straightforward to say, but it is surprising how many advisors doggedly resist changing their minds or admit being wrong about the direction of the markets. Hubris aside, many investment advisors feel pressured by clients into the role of all-knowing expert, and mistakenly believe that they should have seen any and all downturns coming, otherwise they have no right to charge a fee for their services.
To be clear, the role of investment advisors is to develop a plan of investments to match a client's risk tolerance and objectives and then implement the plan by making direct investments themselves or by hiring best-of-breed third party managers. They are not and never will be infallible predictors of the markets. In this vast, interconnected global marketplace, even the savviest managers are vulnerable to fleeting shifts of sentiment. Just ask Barton Biggs, the star hedge fund manager who sold half his equity holdings at the start of July as the market spiraled, only to buy them all back at month's end when the tide had turned.
For a truly productive relationship, investment advisors need to be honest with clients about a change of heart or at least openly acknowledge doubts and uncertainties. If more investment advisors had acknowledged their inability to discern the course of the markets in 2008, perhaps a lot more wealth could have been preserved. For their part, clients need to appreciate the character it takes to truly act as a steward of wealth, and allow reasonable latitude for advisors coping with volatile markets to waffle in judgment or misstep on occasion in trying times.