Advisors must shape their discipline for asset allocation issues.
As usual, there's talk in the industry.
Understandably, it's about future market returns. The scuttlebutt is
that investors can expect single-digit returns for the foreseeable
future and if they don't like it, they'll just have to lump it.
Whether the market predictions actually come true,
wealthy clients continue to demand broader investment choices. Since
the majority of SMA portfolios live within the traditional large-cap
universe dominated by the S&P 500, the predictions could make an
already growing marketplace demand more poignant. But rather than
settle for mediocre returns, some advisors propose looking outside of
traditional asset classes to boost portfolios, which may both defy the
prediction and satisfy client demand.
Rob Brown, chief investment officer of Encino,
Calif.-based GE Private Asset Management Inc., a unit of Genworth
Financial that specializes in SMAs, states that opportunity in the
marketplace doesn't disappear, but it "changes its stripes fairly
remarkably." If traditional asset classes do go through a cycle of
mediocre returns, what will that mean for SMA advisors and their
clients? Let's explore the possibilities and the steps advisors can
take now to stay at the forefront of the SMA curve.
Advisor Str-r-e-t-c-h
One of the ways advisors can help clients deal with
the new predictions is to brush up on their knowledge of other markets
and investment instruments. Forgotten securities such as preferred
stock, utilities, closed-end funds, and different areas of fixed
income-those that may have underperformed during the bull market's
heyday-may shine in the new environment. Alternative asset classes,
such as emerging markets or international ETFs, and various hedge fund
strategies focusing on turnaround or restructure opportunities may also
prove more favorable. Private equity, managed futures and commodities
funds may become more common across a broader range of portfolios.
But many advisors and their clients view some of
these asset classes as higher-risk investments. However, these
instruments may also offer clients enhanced returns and less overall
portfolio risk, when properly allocated in a client's portfolio.
Such focus on asset allocation is the hallmark of
Bott & Associates Investment Consulting Group of Wachovia
Securities. Daniel R. Bott Sr., CIMC and director-investment officer,
states, "In order to make the SMA portion of your business work, you
must have some level of discipline in asset allocation." Bott says this
is a primary area in which advisors should hone their skills. "If
they're not good at it, they'll continue to be on the roller coaster
ride of doing well when the markets are going up and underperforming
when that segment has run its course."
As for international exposure, "It's funny when you
hear an advisor say they invest in international and their exposure is
only 8%," says Gary M. Arford, president of Comprehensive Wealth
Management LLC in Seattle. "In a globalized world, where the U.S. is
going to be one of two, possibly three, significant engines of growth,
that kind of thinking puts these managers [and advisors] at a
disadvantage."
Bott's opinion is that the majority of brokers and
advisors sell the same products. Brown says clients and advisors alike
look at the last 25 years and believe that what worked well during that
period will continue to work well in the future. Veteran advisor and
consultant Marty Jensen, managing partner at United Management Group,
an investment and venture capital advisory firm based in Newport Beach,
Calif., says, "The wealth management industry is a burgeoning
marketplace, and the competition for the high-net-worth segments are
increasing. In that sense, it's becoming more challenging to separate
one vendor from the next," indicating that even SMA platforms are
becoming commoditized.
The comfort zone of "sameness"' will clearly
have to be breached if advisors are to prepare themselves and their
clients for future investment opportunities. Their next responsibility
will be to educate their clients about "out-of-the-box" opportunities
that may be the primary source of greater returns over the next ten or
so years.
Strategies For The New Environment-What's So Different?
The term, "This time it's different" was the
hallmark of the market bubble of the late '90s. According to some, it's
now the hallmark of the real estate bubble. Regardless, advisors need
to understand the underlying reasons why the market environment is
changing and why they must change with it. Is this market environment
really that different?
It is, and it isn't. Says Brown, "Compared to the
last 20 years, it seems to be entering a completely different cycle."
But he stresses this flipside is part of the normal course of long-term
cyclical rotation among various asset classes. So from a long-term
view, such a cyclical change is not that different.
Arford agrees, stressing the importance of
proactivity for advisors. "The big thing advisors are missing today is
proactivity. Graham and Dodd (authors of Security Analysis, a bible of
the industry) said to be invested in the stock market-they didn't say
to buy Standard Oil, GE and Edison Utilities and hold them forever.
Companies change, and advisors must look for where the trend is going.
They must learn to buy low and sell high," says Arford.
Bott stresses the importance of a dynamic asset
allocation design. His group has developed a proprietary method called
DARP-a Dynamic Asset Reallocation Process that identifies the areas
that will provide the best opportunities for making money and
minimizing risk by under-allocating the most vulnerable ones.
Both Arford and Bott have practiced their
philosophies for decades, defying the popular buy-and-hold theory in
the process. Jensen adds, "SMAs are good at optimizing dissimilar
performance movement styles so as to smooth out volatility for the
risk-averse, absolute-return-oriented client. Hopefully, as SMA
platforms evolve, they can begin incorporating the ability to customize
target returns or target volatility patterns. Just as valuable would be
dedicated SMAs for alternative products/instruments such as REITs and
private equities."
The "New World View" Of SMAs
The development of SMAs for REITs, private equities
and other alternative investment choices is an exciting future
possibility. Today, however, SMAs may be combined with ETFs, hedge
funds of funds, private equity investments, managed futures and almost
any other type of investment to provide exposure to various market
areas while also offering the balancing factor to mitigate risk.
In that vein, Charles L. Fahy Sr., senior vice
president at James E. Bashaw & Co. in Houston, has changed the SMA
acronym to represent what he calls strategically managed accounts.
"Oddly enough, it seems to be going back to the way things were when I
came into the business in the 1970s," says Fahy. "You expected
investment managers to go to any discipline where they found value.
Since that time, we seem to have pigeon-holed managers into different
asset classes. If you were good at mid-cap, that became your identity
as an investment manager."
Traditional Thinking Vs. New World Reality
Advisors will need to make a shift in their
thinking-toward looking at other countries, other regions of the world,
and to developing a disciplined strategy for making investments
designed to help clients, while not investing so deeply in an area they
may not fully understand without having a viable exit strategy. "That
saved our bacon in the early 2000s," says Arford. "Advisors will have
to become a lot better at the economies of the marketplace. If they're
going to be paid a fee, they jolly well better do something to earn it!"
Multiple discipline accounts will also begin to
morph. Fahy creates his own multidiscipline accounts by choosing
specific managers he's put through his process.
Some SMA managers have broken from the traditional
mold to create mid- and small-cap portfolios as well as international.
Fixed-income SMAs are also entering the scene-all helping to round out
the SMA palette. SMAs are even being created from portfolios of ETFs.
Brown's firm has created a new SMA category-Domestic
Export. "We've attempted to create new mandates for managers. One of
our concepts focuses on American businesses that are at the absolute
height of global competitiveness. These companies in the United States
thrive on global competitiveness and span a number of very interesting
industries that don't fit any of the traditional style boxes."
Some asset classes aren't suitable for an SMA
structure, such as international small-cap and emerging market debt.
ETFs provide a better structure for these types of exposure.
Will the dour forecasts come true? Asset manager
Frank Gemino, CEO of Henley & Company in New York says, "I learned
early on in this business that you could have Milton Friedman in one
seat, Alan Greenspan in another, and Mike Metz in another, and they
could come up with maybe six different scenarios with 100% conviction!"
Whatever the coming investment landscape, Brown
emphasizes the opportunities advisors have in a more demanding client
environment. "One of the most important factors for advisors and
clients to appreciate is that environments do change. Such changes are
powerful forces but they are also quite normal. The new environment
will allow advisors to demonstrate in a truly value added fashion that
they bring a great deal of expertise to the table from which clients
can benefit. It's so much more than just goal identification,
assembling solutions and tracking-it's the investment expertise the
advisor can bring in terms of crafting that better investment
solution."