Advisers Ditch 'Buy and Hold' for New Tactics
by Anne Tergesen and Jane J. Kim
Thursday, April 30, 2009
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Facing Angry Clients, Pros Turn to 'Alternative' Products; Risk of Missing a Turnaround
The broad decline across financial markets in the past year has persuaded a small but growing number of financial advisers to abandon the traditional buy-and-hold strategy -- which emphasizes long-term investing in a mix of assets -- for a new approach geared to sidestep future market plunges and ease volatility.
Jeff Seymour, an adviser based in Cary, N.C., used to counsel clients to buy a diverse menu of stocks, bonds and commodities, and hold on for the long run. But early last year, he says, he recognized that "the macro-economic climate has changed."
Today, Mr. Seymour keeps about 90% of his clients' money in such low-risk investments as short-term bonds, cash and gold. With some of the small amount that's left over, he uses leveraged exchange-traded funds to place magnified bets both on and against the Standard & Poor's 500-stock index.
"It's a complete rethink of how to do asset management," Mr. Seymour says. Most of his clients are within a few percentage points of breaking even since the shift, he says, while his firm, Triangle Wealth Management LLC, has more than doubled in size.
Buffeted by steep declines in stocks, many bonds, commodities and real estate, many advisers are questioning their faith in long-standing investment principles, such as controlling risk by building diverse portfolios. Some are adding increasingly exotic investments, including products that offer downside protection, to client portfolios. Others are trading more actively -- and say they plan to continue to do so until they see evidence of a new bull market.
To be sure, most advisers are staying the course. They point out that frequent trading leads to higher trading costs and tax bills, and that so-called alternative investments come with some serious downsides. Because the markets for many of these products are relatively undeveloped, for example, investors may face high fees, poor liquidity and a high degree of complexity.
Critics also contend that advisers who scale back on stocks are essentially trying to time the market, and are exposing their clients to another type of risk -- that of missing out on future rallies that could recoup recent losses.
"By abandoning time-proven prudent techniques, they run a serious risk of destroying their own credibility and their clients' portfolios," says Frank Armstrong, president and founder of Investor Solutions Inc., an independent financial advisory firm in Miami that still practices buy-and-hold investing.
The changes come at a time when financial advisers are coming under pressure from clients who are tired of paying fees only to watch their savings evaporate. Advisers have "a lot of cranky clients," says Mr. Armstrong. "They want to see something happen," he says.
Certain advisers have long placed small tactical bets on sectors, countries or regions they expect to outperform the broad market. Many have also placed a small portion of clients' portfolios into alternative investments, such as commodities and real-estate investment trusts.
Offsetting Risks
Now, some are adopting even less-conventional approaches in an attempt to more effectively offset the risks of investing in stocks -- and generate returns in a market they expect to remain depressed for some time. Some have ramped up their use of opportunistic trading to try to profit from short-term rallies and selloffs. Others are turning to "structured products," which are complex investments that often employ options to provide downside protection. Still others are using investments such as currencies or managed futures that they believe will rise when stocks fall.
"Asset allocations built on stocks and bonds are best suited to secular bull markets," says Louis Stanasolovich, founder of Legend Financial Advisors Inc. in Pittsburgh. "But the past nine years have proved that nontraditional thinking makes more sense in secular bear markets."
Last October, Mr. Stanasolovich revamped one of his portfolios that is aimed at delivering relatively consistent returns with low volatility. It currently consists mainly of government and agency bonds, hedge-fund-like mutual funds and a long-short commodities fund. It also holds "managed futures" funds, which seek to profit from gains and losses in commodities and financial futures, including a range of currencies, government securities and equity indexes. From Oct. 10, when Mr. Stanasolovich completed this makeover, through April 27, he says Legend's low-volatility portfolios are "essentially break even." The S&P's 500 is off about 3% over that period.
Brave New Investing World
Some financial advisers are reconsidering their approach. Here's what to keep in mind:
• Frequent trading can lead to higher trading costs and tax bills.
• "Alternative products" often come with high fees and complex strategies.
• Market timing may help dodge declines, but investors may miss the next big turnaround.
Such unconventional approaches appear to be gaining sway. About 15% of the 500 advisers polled between December and March by consulting firms GDC Research LLC of Sherborn, Mass., and Practical Perspectives LLC of Boxford, Mass., say they have made significant changes in the way they manage retirement money over the past year. Among those who have made a change, 21% report increasing their use of opportunistic trading strategies. Eighteen percent say they have become more reliant on structured products and related investments, and 11% say they're incorporating other types of alternative investments.
Two prominent networks of financial advisers -- the National Association of Personal Financial Advisors and the Financial Planning Association -- are sponsoring panels at conferences this year on the subject of rethinking conventional approaches to investing and building client portfolios.
'A Seismic Change'
"There's a seismic change in the market," says Will Hepburn, president of the National Association of Active Investment Managers. "The people who were buy-and-hold-oriented lost a lot of money, and they don't want to do it again."
Meanwhile, financial-services companies are rolling out products designed to lure gun-shy advisers. Last July, Portfolio Management Consultants, the investment consulting arm of Envestnet Asset Management Inc., introduced seven portfolios that invest in ETFs based primarily on signals from quantitative models. Advisers -- who have invested over $200 million since the launch -- can select how much of their clients' portfolios to allocate to this tactical asset-allocation approach. Although many will put between 20% and 40% of client assets in them, some have shifted 100%, says Richard Hughes, group co-president.
Helios LLC of Orlando, Fla., expects to start offering customized portfolios this summer that will enable independent advisers to use options strategies to get exposure to riskier asset classes, such as stocks, with limited downside. In exchange, they give up some potential appreciation.
DWS Investments, the U.S. retail unit of Deutsche Bank AG's Asset Management division, says more financial advisers are using its so-called buffered notes, which offer limited principal protection. "A lot of investing over the last 40 years has been done around traditional asset classes," says Chris Warren, head of structured products at DWS. "But over the last 18 months, the correlation among those asset classes has gone up a lot, so much of the benefits of portfolio diversification really aren't there."
All these structured products add a layer of fees. Helios, for example, plans to charge a maximum fee of 0.95%.
In October, Matthew Tuttle of Tuttle Wealth Management LLC in Stamford, Conn., gave up on buy-and-hold investing. He hired Murray Ruggiero Jr. -- who developed trading systems for managed-futures traders and funds -- to develop similar computer models for the ETFs and index funds he favors. Now, Mr. Tuttle decides what to buy and sell for his clients based on market trends.
"We trust the computer," he says. He has been able to sidestep recent market slides while reducing the volatility of clients' portfolios, he says.
Paying More in Taxes
To be sure, his clients will pay more in taxes. But Mr. Tuttle says no one is complaining. "Would you rather be tax-efficient and have losses?" he says.
Other advisers are looking even further afield for alternative investments. Today, the average client of West Financial Consulting Inc. of Huntsville, Ala., holds about 20% in domestic and international stocks, down from 40% last year. Founder Larry West is currently using bond funds that make tactical bets. He is also recommending greater exposure to alternative investments, including managed-futures funds, bonds that back construction and expansion projects at churches, hedge-fund-like mutual funds, gas-drilling projects, and private partnerships that invest in real estate. He also holds positions in two private partnerships that invest in railroad cars.
There is some evidence that advisers who practice the traditional buy-and-hold philosophy are losing clients to managers trying new approaches. Jeff Porter of North Canton, Ohio, left his buy-and-hold-oriented planner last year and moved his account to Brenda Wenning of Newton, Mass. Ms. Wenning had been a financial adviser for years at a firm that practiced a buy-and-hold approach, but started actively managing clients' money -- in part by using leveraged ETFs -- when she opened her own practice in May 2008.
"I realized when I saw the market starting to change that the old buy-and-hold strategy just doesn't work," says Mr. Porter, whose account was already down 20% last year by the time he went to Ms. Wenning. She immediately shifted his investments to cash -- a move he calculates saved him about $80,000. Since then, he says, Ms. Wenning has been slowly moving back into the markets. His old adviser hadn't bought or sold a single investment in his account last year.
"You're paying these people a fee to manage your money," Mr. Porter says. "They're really not earning their keep."
Write to Anne Tergesen at anne.tergesen@wsj.com and Jane J. Kim at jane.kim@wsj.com
