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Following the twin market implosions of the past decade—first tech, then real estate—many retail financial advisors are looking for more tactical, meaning active, asset allocation solutions for client portfolios to dampen volatility, improve total returns and avoid market catastrophes. At least some of them fear that if they don’t dramatically change the way they allocate client portfolios, moving away from traditional buy-and-hold investing strategies, they could lose clients. So say a handful of advisors and an investing expert.
Things could get especially bad if another bear market hits, says Ron Carson, founder and CEO of Carson Wealth Management Group. “[Investors] are hanging on by a thread right now, and I don’t think they’re going to forgive.” A Natixis Investor Insights Study found that 63 percent of investors are now paying more attention to risk than ever before. If the market nose-dives, advisors are going to want to have a different story to tell. They can’t just tell clients to hang on and wait it out like many of them did in 2008.
Meanwhile, clients are expressing specific interest in tactical solutions. “Clients have a very hard time [increasing their equity exposure] because of the experiences that they’ve been through the last few years, and if you can find something that’s a little more tactical, then it’s little more palatable to a client today,” said Don Phillips, managing director of Morningstar. “You can have the greatest paper results in the world, but if your clients don’t stay on board, it’s all for naught.”
According to a survey by Cerulli Associates, the number of FAs using either a pure tactical allocation or strategic allocation with a tactical overlay is now at 61 percent, up 8.3 percent from 2010. A Jefferson National survey from September 2011 found that 75.5 percent of advisors believe that active portfolio managers can outperform an index over the long term. In Jefferson National’s 2010 survey, 66 percent of advisors said clients were more confident with a tactical asset management strategy, while only 34 percent said clients were more confident with a traditional buy-and-hold strategy.
Cerulli defines pure tactical allocation as the advisor’s ability to alter a client allocation without any preset bounds based on forward-looking market expectations. Under a strategic allocation with a tactical overlay, the advisor starts with a long-term client allocation, but makes short-term deviations from the long-term strategic weights to capture alpha or move away from risk, Cerulli says. Pure strategic asset allocations have specific targets for each asset class and allow for periodic rebalancing. Buy-and-hold, akin to strategic, is a passive approach and involves buying and holding positions for long periods of time.
Business Risk
Kenneth Solow, chief investment officer and senior partner with Pinnacle Advisory Group, believes that sticking with strategic asset allocation is a business risk.
“But now that we might be heading into the third bear market in the last decade, people are beginning to ask, ‘Well, what happens when returns are a premium?,’ and strategic asset allocation itself becomes a risk,” said Solow, author of Buy and Hold Is Dead (Again): The Case for Active Portfolio Management in Dangerous Markets.
“I think that the fact that we had these two big blowups in short sequence, I do think it poses a challenge where we really do have one more shot at this,” said Lee Munson, chief investment officer of Portfolio, an RIA, and author of Rigged Money: Beating Wall Street at Its Own Game. “And we are, in a sense, fighting for the soul of the U.S. investor.”
About four years ago, Scott Sampson, president of Sampson Investment Management in Danville, Calif., started getting more tactical with his clients’ portfolios using the separate account version of the Aston Dynamic Allocation Fund (Ticker: ASENX), managed by Bryce James, founder and CEO of Smart Portfolios. About 30 percent of Sampson’s clients have already retired, and can’t afford to lose any more of their assets, he said.
“These people can’t live with the message, ‘Well, the market went down 40 percent last year, but don’t worry,’” said Sampson. “‘The market returned an average of 9 percent over the last 100 years, so everything will come back.’”
“If we go and we see 600 or 700 on the S&P and we drop 30-40 percent from here, I think finally people are going to say, ‘I’m done,’” said Carson, who has used his “advance and protect” strategy for 10 years, which actively reallocates based on risks in the marketplace. “‘I’m going to either do it myself,’ which I’m not so sure they can do it any better, or they’re going to gravitate towards firms that have proven that they have an ability to navigate those waters.”
Debate
The value of strategic or buy-and-hold investing versus tactical asset allocation strategies has long been debated, especially in these pages. A July 2009 story called into question the traditional asset allocation methods of modern portfolio theory. And in December, we wrote that while tactical movements are growing, they could end up turning into the industry’s next big embarrassment. Tactical allocation has long been derided as market timing.
Rick Ferri, founder of Portfolio Solutions and author of The Power of Passive Investing, would argue that buy, hold and rebalance is in the best interest of the client and that individual actors don’t have the skill or track record to beat the market by active management. Tactical allocation is not in the job description of an advisor, said Ferri.
“Any client that goes with a tactical allocator who doesn’t have 50 years of a track record is really taking more risk than they need to.”
“The academic literature, if you will, strongly suggest trying to jump in and out of the market is a fool’s game,” said Morningstar’s Phillips. “If you set a long-term strategic goal and you just stay fairly constant and moving towards that, you’ll do better in the long run. What advisors are saying is, ‘Well, look that’s great on paper, but I’ve got to deal with a client, sit down with them every quarter in the interim and if the volatility gets too great or if they don’t feel I’m doing enough to protect them, I’m not going to keep the client.’”
So what’s the solution? Taking a more tactical or active approach can be costly and timely, and as Ferri says, not everyone can do it. Some say you can make things more palatable for clients by adding a tactical overlay to a core strategic portfolio, which allows advisors to make tweaks when necessary and let the client know you are doing something. Others recommend outsourcing asset allocation to outside firms that specialize in more tactical approaches. For example, Carson makes his “advance and protect” strategy available on Envestnet’s platform, giving other advisors’ access to it. Andrew Costanzo, of Costanzo Financial Group, accesses a tactical strategy through his broker/dealer, Cetera, which offers tactical asset allocation models on its investment platform.
“Us telling our clients, ‘You’re average; this is what happens in this type of market.’ They don’t want to hear that anymore,” Costanzo said. “No one wants to be average. They want to be better than their neighbors, and you have to show that you have the solution and represent that solution in a way that will keep them engaged in the process.”