Which means, in order to protect your clients, you would have had to time the market and go to cash-something most serious advisors are hesitant to do. Or would you have? Stanasolovich says the 2008 stock market losses haven't moved his clients' retirement targets.
"I don't think we have any clients who won't be able to retire on schedule," he says. "Some might need to change their lifestyle a bit, though." As far as his clients' losses, he says, "Some were down as little as 6% last year, others were in the 9%-10% range, and the worst situations-in all-equity portfolios-took a 15% loss."
He attributes his low numbers to his use of managed futures, long-short commodities, and the switch to high-quality bonds. As the editor of the Risk-Controlled Investing newsletter for advisors, he believes we haven't seen an economic situation like the one we're in since the Great Depression and, hence, we need to invest as if this were the 1930s, using strategies such as heavy shorting, buying very high-quality bonds, avoiding equities and sitting on large amounts of cash. "In our most conservative client portfolios, we've got 40% in cash, and no less than 15% in less-conservative portfolios," he says.
"We've become convinced we should be using managed futures in almost every portfolio, for almost any scenario we can envision. We were doing this before the current market, but we've now become more comfortable with these strategies and we're creating hedged portfolios with what is predominantly a managed future strategy."
The question remains: Do we need to completely overhaul our notion of asset allocation in light of current events? Connelly says it's not a matter of modifying one's asset allocation philosophy, but of implementing the one we've already got. "I have major categorizations of asset classes, like most advisors, but what's important is to always make sure there's something material in each bucket so we haven't overweighted stocks, bonds, gold, whatever. The other thing is to say not only do we not know the future returns or volatility of particular assets," he continues. "We don't even know the distribution curve that best describes them in the future. If you think stocks too risky, then you might try to guarantee some income streams against market volatility with guaranteed products or fixed annuities, for example."
Gibson essentially concurs. "I think the one thing asset allocation promises and which it has delivered is to make the portfolio, as a whole, take on less average risk and have a higher compound return than the average return of its asset classes," he explains. "Yet it doesn't mean you can't get into a scary environment, and asset allocation won't eliminate all risk on the downside."
Stanasolovich has a somewhat different take: "For us, asset allocation has always been more strategic in nature, where we might add or sell a few funds each year, but now we're feeling the need to be more tactical in our allocations and radical in terms of the time frame in which to make changes."
For example, he says, in late September/early October, Legend felt the need to move quickly with sales of equities. "And virtually everything we sold went down more after the sale," he says. "We then made sure every portfolio [except all-equity portfolios] had managed futures exposure. Yet we realize that not every client can be pigeonholed, so although the majority of our clients get lower-volatility strategies, many have other portfolios we run at an increased risk level."
For example, Legend's "Ultra-Conservative Lower Volatility Portfolio," which has 75% cash and debt to 25% equity, includes equity line items like Undisclosed Managed Futures L.P. and Caldwell and Orkin Market Opportunity. The firm's "Aggressive Lower-Volatility Portfolio," at the other extreme, is 26.5% cash and debt and 74.5% equity, the latter including securities such as Diamond Hill Focus Long-Short and Rydex Managed Futures. So while Stanasolovich has moved to a more tactical approach to asset allocation, he's still an asset allocator.
Perhaps traditional asset allocation doesn't need a total face-lift, say these experts, but there are times when it simply can't protect against wide-scale portfolio devastation. As Gibson says, that marble that represents a plus-two-standard-deviation downside return is in the urn waiting to be picked on occasion. When that happens, he says, his favorite quote by Paul Volcker, past chairman of the Federal Reserve, comes to mind: "You cannot hedge the world." "I love that quote," says Gibson. "If you're living on this planet, you can manage risk, but you can't eliminate it. That was the essence of Volcker's comment, and we learned that lesson in 2008."