In this article I wrote for RIA Biz (an industry site) in April 2010, I discuss how Investment Advisors can no longer outsource their market risk-management decision making to a computer program or third party asset manager.
Advisors: Reclaim Management Of Your Clients’ Funds
Wednesday 4.14.10 by Ric Lager
Contrary to conventional wisdom, RIAs can’t just be content to manage relationships and recruit new clients.
For the last 35 years, investment professionals were able to slide by with pie charts and modern portfolio theory (MPT) projections because the stock market continued to climb, for the most part, throughout their careers.
The traditional buy and hold investment strategy, the core of MPT, served investment advisors and their clients well in the 1980s and 1990s.
Traditionally, the Wall Street investment advice model has been to gather client assets, allocate those assets under the guidance of data garnered from a risk-management questionnaire and maintain the client relationship with golf outings and the requisite “client appreciation” events.
In reality, where the advisor can — and should — add value is in the area of portfolio allocation and management.
Contrary to today’s conventional wisdom, advisors today need to spend more time managing money and less time managing relationships and recruiting new clients.
Arms length
They can no longer outsource their market risk-management decision making to a computer program or third party asset manager, as this leaves them at arms-length from the engine that drives their clients’ financial lives. They need to take control of their clients’ assets in order to avoid another downturn in the market and safely participate on the upside.
As we have learned, investing a portfolio to match a pie chart allocation does not guarantee success nor does it eliminate the prospects of colossal failure. A broad portfolio of computer-generated and theoretically allocated stock market investments can no longer be presented to investors as likely to appreciate at a higher rate than annual taxes and inflation.
The reality is that the famed Ibbotson charts that show various asset classes taking leadership year-by-year doesn’t highlight the case for pie-chart allocations. It actually challenges the validity of sitting by idly as several slices of your allocation pie take a beating each year.
Instead, advisors must execute a tactical asset allocation strategy that focuses on assets, sectors and stocks showing the potential for most gains while at the same time be on the watch for investments that have diminished in viability.
Asset classes on the upswing
This will enable investors to buy into asset classes on the upswing. Implementing such a strategy requires the advisor to identify the key buy signals, but also the signs that dictate an exit.
Do you have a risk management plan?
It doesn’t matter how many designations you have behind your name. If you can’t articulate a logical, organized and disciplined risk management game plan to your clients in the early stages of a stock market decline, you should reevaluate your commitment to this business.
Consider the following to create a risk management plan:
- When you buy is more important than what you buy. Use technical analysis to make emotionless investment decisions and quantitative momentum to execute trading decisions.
- Take the data gained through technical analysis and determine if the market is on offense or defense.
- If the market is on offense, decide what asset class, indices and sectors are best to be invested in.
- If the market is on defense, be sure that stop losses are in place on existing equity positions and raise cash levels to best weather the potential market correction.
- New era of investing
You don’t have to watch the stock market every day or be an expert on U.S. economic cycles to know that there will be much more volatility and risk associated with managing client stock market assets in the future.
Numbed long-term investors
If the U.S. and global economies continue on their current path of slower economic growth, a buy and hold investment strategy will not work nearly as well as it continues to be advertised and recommended by financial advisors to numbed long-term investors.
Add to that the fact that the Federal Reserve will need to stop the era of “free money” and the historical stimulus programs introduced over the past two years, and the future of any buy and hold investment strategy becomes a less valid and practical investment strategy.
Financial advisors today need to present a logical, disciplined and organized plan to manage a client’s retirement account in up, down or sideways market environments. As anyone who even casually follows the stock market knows, we have had to navigate all three types of environments over the last ten years.
Ric Lager is founder of Lager & Co, co-creator of the No More Pies investment series for advisors and author of “Forget the Pie: Recipe for a Healthier 401(k).” No More Pies provides a call to action for advisors who want to rethink their investment process, reduce their reliance on outside money managers and improve client retention. The seminar also presents a road-map for advisors to take a hands-on approach with their practice. For more information on Ric Lager and No More Pies, please visit www.nomorepies.net.
Here is the link to the article in RIABiz
