With all that’s occurred in the past 18 months, financial advisors have had a lot to ponder. Is Modern Portfolio Theory sufficient? Is buy and hold a sucker’s bet (more like “buy and hope”)? Is 60/40 stocks to bonds diversification enough? Or do clients need exposure to other asset classes? As tends to happen when a crisis hits, traditional ways of thinking get challenged and new theories emerge. Right now, the implications of ongoing government spending in response to the economic meltdown is the hot debate and is provoking a raft of questions from clients, not just related to stocks and bonds, but to taxes, real estate and no doubt many other macroeconomic factors.
With that in mind, we were somewhat surprised by the contents of this column in the Friday edition of the New York Times. The author, who attended the Financial Planning Association’s annual meeting in Anaheim oct. 10-13, moderated a panel with five financial advisors about the toughest questions they were hearing from clients—and how they were responding. All of the advisors interviewed were well-known, successful, reputable members of the financial advice community, some of them are frequent and valued sources for this magazine.
But something about the tone of the responses, or at least the way they were presented in the column, didn’t sit right with us. They didn’t seem to reflect a sense that there had been any thoughtful debate in the financial planning community about recent market events, and with the benefit of hindsight—or that the speakers had considered recent challenges to traditional ways of thinking about investments or retirement. Realizing that there was probably plenty of interesting conversation and commentary left on the Times’ cutting room floor, we have parsed the planners’ answers from the column.
When asked, “Why didn’t most financial planners see all of this coming? Weren’t the signs obvious?,” one FA, named in the article, replies: “This question actually presumes that there is something wrong with not having seen this coming,” and then continues, “We live in a chaotic system, and chaotic systems are not predictable. But we know the range of possibilities, and this was always a possibility.” The answer seems like both a copout and a contradiction. Yes “this” was always a possibility, she says, but we couldn’t have seen it coming. Granted, many financial advisors may feel they are not responsible for the mess that the investment banking divisions of the big Wall Street banks got us into. And no one has a crystal ball, or can say they knew the global plunge in all asset prices would happen when it did. But many did see the symptoms leading up to it, and some managed to protect their clients against it.
Robert Schiller, among other students of valuation, said housing was an identifiable bubble years ago. (In June, 2005, our own magazine ran a cover story about real estate titled, Duck and Cover.) Many said the financial sector had ballooned beyond reasonable size. And isn’t the fact that such events are possible, and are becoming more frequent, a good argument for re-examining the way portfolios are managed and constructed? Is there room for greater discussion about Modern Portfolio Theory? What about applying Post Modern Portfolio Theory and behavioral economics to planning for risk in client portfolios? How about advisors like James Breech? While no one has all the answers, a discussion about whether the old models still work seems essential to the financial planning industry.
When asked, “Is asset allocation dead?,” another advisor replied that, “Asset allocation is not designed to protect against market movements in very short-term time horizons. It’s designed to provide optimal performance results over very long periods of time, and there’s nothing to suggest that that expectation will not be fulfilled.” The problem is, many recently retired investors are going back to work because of destroyed portfolios. They may wish to at least discuss complementary strategies to their strategic asset allocations beyond quarterly rebalancing. In other words, if you are using a system that is not designed to protect against market movements in very short-term time horizons, then shouldn’t you at least try to design one that partially protects those close to retirement? Perhaps there is room for tactical adjustments?
Mebane Faber, among others, makes a convincing case for the use of tactical management based on technical analysis. Faber also recommends copying the asset allocation of Ivy League endowments, which spread their assets around among several different markets and alternative investments. These days even retail investors have access to all kinds of ETFs and mutual funds which offer hedge fund-like strategies.
David Einhorn, founder of the hedge fund, Greenlight Capital, speaking at the Value Investing Congress, a gathering of esteemed asset managers in Manhattan on Monday, had some words relevant to both of these question and answers. Einhorn says he learned an important lesson in last year’s crash. “The lesson that I have learned is that it isn’t reasonable to be agnostic about the big picture. For years I had believed that I didn’t need to take a view on the market or the economy because I considered myself a ‘bottom up’ investor. Having my eyes open to the big picture doesn’t mean abandoning stock picking, but it does mean managing the long-short exposure more actively, worrying about what may be brewing in certain industries, and when appropriate, buying some just-in-case insurance for foreseeable macro risks even if they are hard to time…” Ultimately, what he is saying is that while long-term investing is important, many investors have shorter time horizons and need active management based on market valuations, technical trading patterns and economic expectations.
Lastly, the Times columnist asked, “How can people know for sure that they are not dealing with crooks?” In response, one of the panelists replied, in short, one cannot. It’s true, if someone wants to steal by committing outright fraud, they will get away with it—until they get caught. Another FA says using FAs who custody assets at an independent firm, such as a Schwab or Fidelity, would be prudent. And another says clearer monthly account statements that show money flow would be good. But there’s no mention of improved regulation and enforcement. Not more, just better. For clients and investors scared stiff and distrustful, this might have been nice to hear just as the financial services lobby appears to be crushing any meaningful reform attempts—especially coming from the financial planning elite.
Ultimately, one of the advisors on the panel said that she is counseling her clients to save more money and offering them ways to enjoy cheap entertainment. But is this really what financial planners are paid so handsomely to do?