Are we in a bear market for equities already? Or are we heading toward a bear market? And is it foolish to even try to guesstimate where in the market cycle we are? For financial advisors, how they identify with the above questions can influence the current shape of their client portfolios. 

One thing is certain: The bull market in U.S. stocks that began in March 2009 is one of the longest on record. And most market watchers agree that equity valuations are stretched, at least in the U.S., which means there’s likely limited upside. Or, to put it another way, there’s more downside than upside potential. Whether that equates to a bona fide correction or a full-blown bear market in the near future remains to be seen. 

Naturally, advisors have different takes, strategies and philosophies regarding the markets, so their responses to current market conditions will reflect that. 

Buy-N-Hold (And Rebalance)

Count Peter Lazaroff in the camp that says it’s foolish to speculate on the timing of a bear market. 

“Positioning portfolios for a bear market is a loser’s game,” says Lazaroff, a wealth manager and director of investment research at Plancorp, a St. Louis-based registered investment advisor. “More often than not, advisors and their clients will lose more money trying to avoid the losses of a bear market than they would temporarily lose in a bear market itself.”

Lazaroff considers Plancorp to be a buy, hold and rebalance shop. “We don’t view rebalancing so much as a return enhancer but more of a risk manager,” he says. “We’re more concerned with keeping the risk, or volatility profile, of a portfolio in check.”

He notes that Plancorp adheres to a simple philosophy: Less trading is better. “We’re not that concerned because down markets happen much less often than up markets, and the returns are disproportionately larger on the upside than [the drops are] on the downside,” Lazaroff says. “To us, that’s the cost of being a long-term investor.”

Rather than maneuvering portfolios to avoid losses, he adds, Plancorp believes what’s more important is educating clients on how regular these losses are so when the losses do happen the clients are more likely to stick to their plans.

Resetting Expectations

Similarly, Bob Weisse doesn’t fret over the timing of a bear market. Instead, he’s more focused on valuations and how that can impact returns. 

“We look at valuations, and valuations are above historical averages, but it depends on what metric you’re looking at,” says Weisse, partner and chief investment officer at Heritage Financial Services, an RIA in Westwood, Mass. “But they can stay high for an extended time period, so we’ve reset expectations for an expected return from equities.”

He notes that long-term average annual U.S. equity returns have traditionally been closer to 9% to 10%, but his firm expects returns of 7% going forward. Given that, and his belief that fixed income isn’t attractive now, Weisse says one of his firm’s biggest focuses during the past couple of years has been on finding truly non-correlated alternative investments to reduce exposure to both the bonds and equities. 

“We allocate 30% to alternatives for most clients,” he says, noting the allocation is equally split three ways between the Stone Ridge Reinsurance Interval Fund, managed futures (with AQR and LoCorr Funds) and the AQR Style Premia Alternative Fund, which takes a long/short approach across many different asset classes globally. Heritage trims its exposure to equities and fixed income by about 15% each to fund this 30% allocation.

“We’re focusing on asset allocation and diversification, and we’re more diversified than ever,” Weisse says. 

Active Management

The folks at Pinnacle Advisory Group Inc. believe it’s better to take action rather than just sit on their hands and rely on the buy-and-hold, fixed-allocation-of-asset-classes approach espoused by modern portfolio theory.

“We think buy-and-hold is a bad way to risk-manage somebody’s portfolio,” says Rick Vollaro, chief investment officer at Pinnacle, a Columbia, Md.-based wealth management firm that builds active and tactically managed portfolios. 

Pinnacle has developed three risk-managed strategies that, depending on the approach, blend a combination of core, satellite and quantitative approaches to portfolio management that can change allocations based on five different methods of investment value. Pinnacle relies on mutual funds and exchange-traded funds—mostly the latter—to implement its strategies.

Its Dynamic Prime strategy, for example, includes five different benchmarks ranging from very conservative to very aggressive.

Its Dynamic Market strategy contains a traditional diversified portfolio most of the time, consisting of a core allocation (70% of the portfolio) and satellite allocation (30%). At market extremes, the satellite portion can be actively reallocated to hedge the performance of the diversified core portfolio. 

The Dynamic Quant strategy uses the “moderate growth” portfolio of its Dynamic Prime strategy as a core portfolio, with the remaining 40% in a sophisticated, proprietary quantitative model portfolio.

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