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."