From the December 2008 issue of Wealth Manager Web • Subscribe!


"1992 is not a year on which I shall look back with undiluted pleasure. In the words of one of my more sympathetic correspondents, it has turned out to be an 'Annus Horribilis'."--Queen Elizabeth II, at the end of a year when the monarchy was beset by scandals and a fire damaged Windsor Castle.

As global economies braced themselves for their worst crises in decades and markets went into a tailspin during the second half of 2008, most investors would likely express sentiments similar to those of Britain's monarch.

For their part, wealth managers have intensified their regular communications with clients to try to allay anxiety in the face of deteriorating conditions, revisit and reinforce existing plans, and discuss investment opportunities ahead. Conversations with a sampling of wealth managers indicate that the majority of their clients--although clearly concerned--are taking the year's deluge of bad news in stride. Some clients, however, are understandably less sanguine.

Robert Palmer, president of Plante Moran Financial Advisors in Southfield, Mich., says his firm's professionals have engaged clients in a process with three major components. The first is making sure they have adequate cash reserves. "We don't want anyone to be in a position where they're forced to liquidate anything," he says. The second priority is refocusing on their plan. "We believe clients should have a very stable equity-fixed income allocation, and that they don't change that based on market conditions. We reaffirm that policy, and certainly in these times," he says. "People are learning a lot about their risk tolerance; they're also being impacted by the rate of return they need to achieve."

The third component is making sure the firm and its clients have a deep understanding of how underlying managers are repositioning their portfolios and whether certain opportunities exist at the sub-asset-class level that clients should take advantage of.

Amanda Gift, vice president of Signature Financial Management in Norfolk, Va., says conversations with clients have centered on two issues. "Do our clients have enough cash? The answer has been resoundingly 'yes.' We've had a significant weighting to cash in our client portfolios for about nine months now. The second thing we talk about with clients is whether there has been any permanent loss of capital in our clients' portfolios. Positive answers to those two questions tend to ease clients' minds somewhat," Gift says.

At Crestone Capital Advisors, newer clients who haven't been through a full market cycle tend to be edgier than longer-term clients, says Michael Sherman, a principal in the Boulder, Colo.-based firm. "The ones who have been with us 10 or 15 years understand this is a cycle," he says. "They're more attentive to things, but not as panicky as the others."

Retirees and those near retirement also have reacted more strongly to the market turmoil. "We have had a handful who have been beyond concerned to the point of panic," says Plante Moran's Palmer. "These have been so panicked, they have wanted to move large amounts of their portfolios to cash. Most of these have been people who are in or near retirement, where they've been very concerned about their financial independence." He says that education about the markets has helped ease their minds.

In its increased communications with clients, especially retirees, Clarfield Financial Advisors in Tarrytown, N.Y. "is trying to gauge whether their risk tolerance is changing," says Robert Varriano, a principal. "We're a relatively conservative firm to begin with, so we don't have hedge funds, we don't do private equity, we don't do leveraged funds. But you're having conversations with retirees, and maybe you're taking a 50% or 55% fixed income portfolio a month ago and beginning to increase it to 65%, and doing that in reassessing a client's risk tolerance."

Some clients stand apart in their reactions to the market turmoil. "I was on a call yesterday with a client who was giddy," says Mike Henderson, chairman of the South Region of GenSpring Family Offices in Palm Beach Gardens, Fla. "He said, 'I just love a bear market.' He's a very forward-thinking guy; he's been around a long time, so he views it as an opportunity. He understands that when the market gets panicked, and it's somewhat panicked, everything gets sold, and some things deserve to be sold and some don't deserve to be sold down to the levels they are. So, it's just the recognition that when the market borders on irrational, that's going to create some real buying opportunities for those with the stomach to deal with it."

Other opportunistic clients aren't so investment savvy. Daniel Gaugler, the chief executive of Fairway Wealth Management in Cleveland, says he is getting callsalmost daily from a few clients who want to take advantage of the market decline. "And this is not a good thing," he says. "The people who are trying to act almost daily or weekly--over the past six weeks, it's so dangerous with the volatility in the market. A few clients are trying to play the timing game."

A welcome new year

Wealth managers and their clients are, of course, looking ahead to 2009 and where the best opportunities may exist. "Given the bloodbath in the public markets, in the next 12 to 18 months it's got to be in equities and then, secondarily, in all the spread product from MLPs to junk bonds to REITs to convertibles," says Sherman of Crestone.

Palmer says he and his colleagues at Plante Moran still believe in large-cap domestic core equity allocations because those companies should have stronger balance sheets after the crisis and be in abetter position going forward. But they also see other opportunities.

Palmer expects a return to an inflationary economy in the next three- to six-months, and when that happens, there may be opportunies in certain fixed-income securities and severely beaten down commodities, he says. "Anything with any sort of credit spread risk on the fixed-income side has really been hit hard, so we think there are enormous opportunities on the fixed-income side for clients to potentially take a little more risk than they historically have done on the bond side--but still not the risk of the equity side--and potentially get close to equity-like returns."

Gaugler says Fairway builds portfolios with 12 different asset classes and with subgroups within those. "Going forward, it's a matter of making sure portfolios have the right exposure to all these asset classes," he explains.

Clarfield's conservative approach will favor tax-exempt, very high-quality fixed income, says Varriano. This means "you don't just look at a AAA or AA bond and say they're good. No. What is the backing of one AAA bond versus a AA bond? Is there a reserve in place? What is the municipality's credit like? What's its surplus like? We are pushing our municipal bond managers to look at the underlying credit of every single bond and [ask], is there a reserve? Is it funded?"

Henderson says GenSpring has never been a big investor in municipal bonds because the firm's professionals think low volatility alternative managers can do significantly better without significantly more volatility. But things are different now. "You're seeing just crazy pricing in municipal bonds," he says. "You can get very high credit quality between 5.5% and 6.0% tax free; that's one of the more conservative credit market plays."

Many wealth managers who have added alternatives to their clients' portfolios as a means of diversification continue to favor these investments. For example, according to Signature's Gift, "A typical client portfolio will have exposure to hedge funds, several varieties of private equity, real estate, and oil and gas trusts."

Palmer says Plante Moran's professionals like alternative investments and implement them primarily through a multi-strategy hedge fund of funds. "And for clients with the asset base to add things like private equity and venture capital and real estate partnerships, they can do that and get the diversification that goes with it and getdiversity of managers and do it at a very cost-effective rate."

Henderson says GenSpring doesn't view hedge funds as an asset class, but as just another pool of talent. "We categorize the hedge funds we use as being either equity risk or bond risk. The equity risk means it's going to have more equity-like returns and more volatility, although not as much as traditional long-only equity. And bond risk is exactly that. We use hedge funds largely as a substitute for fixed income because we feel that over the long haul, we'll get significantly higher returns without significantly greater volatility."

One of the reasons GenSpring's clients have been cushioned this year, Henderson adds, is that the firm has put commodity trading advisors in most of its clients' asset allocations. "CTAs have done very well this year; that has offset some of the losses in other areas of the portfolio. We continue to feel that's something good to have in the portfolio as an insurance policy because they tend to do well when equity markets are doing poorly."

According to database provider Barclay Hedge, which tracks the performance of hedge funds, CTAs and funds of funds, the Barclay CTA Index was up 7.1% for the year through September versus a loss of 19.3% for the S&P 500 index.

Crestone's hedge fund allocations have done reasonably well this year. "There has been more volatility, certainly in September, than we would have thought," says Sherman. "There were a lot of factors in September that hurt us, but overall they're serving the job we put them in the portfolio for. Our clients may have been surprised by our returns in September, but you've got to focus them more on a longer time frame." He notes that Crestone's trailing 12-month hedge fund return in the fourth quarter was down about 5%.

Gaugler made a similar point to Fairway's clients. "We were able to show clients that for the year to the end of September, hedge funds were down half the broader market. And hedge funds delivered what they were supposed to--until October." The Barclay Hedge Fund Index was down 12.3% through September.

Henderson says the hedge fund sector is the area GenSpring's clients least understand and have more questions about. "It's only human nature that even if the damage is only half as bad as in the long-only space, because of a lack of understanding and headline issues, they tend to give us more questions in that space than in other parts of the portfolio," he says. "But they also recognize that over the long run, they perform beautifully, just the way we would want them to. This year, they haven't performed as well as we would have liked."

Looking ahead, Palmer says, "Hedge funds still have a good place in people's portfolios," despite losses in September and October. "We're still encouraging allocations that people have in that market." The key, he says, is to have multiple managers and multiple strategies. He notes that Plante Moran often uses Chicago-based Grosvenor Capital Management's fund-of-funds products. "We get a lot of comfort with their process, size and experience. They have a 40-year history in the space."

A boon to estate planning

The global economic crisis has brought estate and tax planning to the fore inrecent months. "The silver lining in this bad market is that there are three things causing some wind at your back in terms of estate planning," says Henderson. "One is obvious: It's a great time to be looking at strategies for moving assets down to the lower generations because values are so much lower than they have been; that's the simple one."

Partly a function of the market but more a function of how volatile the market has been is another play on that, he says. This relates to assets such as hedge funds, which typically have some restrictions on liquidity. "When appraisers value an asset that has limitations on its liquidity, that actually gets factored into the valuation. And so for certain types of assets, particularly hedge funds, in addition to the values being lower, the valuation discounts that get layered on top of that are higher today simply because volatility has been so high. Discounts go up when volatility is higher," he points out.

The third component is the economy and very low interest rates. "There are a lot of estate planning strategies where lower interest rates very much increase the efficiency of the strategy." He cites in particular grantor retained annuity trusts (GRATs) and charitable lead trusts (for more about GRATs, please see "Make it Happen," WM Nov. 2008).

In tax planning, says Palmer, "we've been very aggressive with our clients in taking this market downturn to very proactively manage the tax strategy. That's a polite way of saying, trying to capture some of the losses that have happened in the market, but still allowing people to stay fully invested [so that they're not out of the market when it turns upward]. We're very aggressively generating tax losses and have been doing that all year--but more now."

Tax planning has been at the forefront at Signature as well, says Gift. "Clients now have some losses that we may end up taking. We think there's a high likelihood for taxes--both ordinary income and capital gains--to be higher in the future. So, whereas ourconversations six months ago were about selling out of your equity holdings andresetting your basis, they have morphed into a conversation about losses we can take to carry forward for the potential of gains that will be more costly in the future."

Giving wisely

Wealth managers are seeing some paring back in their clients' charitable giving this year, though not a wholesale retreat. "A client yesterday said he would halve his charitable gifting this year," says Clarfield's Varriano. "He's being more conservative for himself; instead of giving away $100,000 this year, he's giving $50,000 and will retain the other $50,000. Unfortunately, people sometimes might cut charitable giving for a year. People are skeptical about giving away assets in a depressed market."

Henderson says that a lot of GenSpring's clients have a large position in someconcentrated security, which if sold willresult in a huge capital gains tax. Often, they will earmark that stock for a charitable contribution. "One of the tax breaks you get is a full bear market value deduction for public securities even though you never realized a gain or paid taxes on the gain. If you give that asset away, you get a full bear market deduction without ever having to pay taxes on the gain. Obviously, it's better than selling it, paying tax, and then giving away cash."

However, current market conditions have made some clients reluctant to use the securities for charitable giving. "Because they feel a lot of the stocks are really, really undervalued now, they're less inclined to give them away--primarilybecause even though it's not affecting them, it's affecting the charities they're trying to benefit. This is the same reason they might not want to sell even if there wasn't a charitable angle: The charity's going to turn right around and sell it. They may not be inclined to have an asset disposed of when they feel it's a lot less than true value. And obviously, it also affects the tax deduction because the lower the value, the lower the tax deduction."

Palmer is finding a similar reaction among some of Plante Moran's clients. He says that historically, people use a lot of appreciated assets in their philanthropy, and because the amount of appreciated assets isn't what they had before, there may be some slowdown in charitable giving. However, people who have made longer-term philanthropic commitments and perhaps already committed assets in a side fund are contending with a different issue, he says. When they find that the values of those assets have decreased, they are looking to get the numbers back up to what they had originally targeted.

Gift says she hasn't seen much change in charitable giving among Signature's clients who are philanthropic--especially clients (with $25 million or more) who have the assets to be fairly discretionary about what they do. "The only change is that they are more aware of a bigger need," she says.

This tumultuous year has called upon wealth managers' full panoply of skills to calm worried clients and keep them focused on their plans, implement tax and estate planning strategies suited to the current environment, and search out investment opportunities in the new year. Communication with clients--much more of it--has been critical this year as markets have ping-ponged by hundreds of points in a day and economic news has gone from bad to worse. Plante Moran's Palmer perhaps speaks for many other managers when he says, "The overarching thought we've tried to get into all our communications is focus on your long-term strategy, take stock of things you currently have going on, but stay calm and stay focused on achieving your long-term goals."

Michael S. Fischer is a New York-based financial writer and editor. He can be reached at

Reprints Discuss this story
We welcome your thoughts. Please allow time for your contribution to be approved and posted. Thank you.

Most Recent Videos

Video Library ››