Back in the frothy run up to the dot.com crash in the late '90s, I had the temerity to tell a group of financial planners that they might want to think about letting their clients enjoy a small portion of the very handsome profits they'd accumulated over the preceding bull decade. My thinking was that it's easier for people to stay
disciplined when they can see a tangible benefit from their dogged sacrifices. I wasn't suggesting anything major--a long vacation in the south of France, a bigger diamond for the missus, or a better country club--anything that would let clients feel rewarded for their diligent saving and investing. Seemed reasonable to me.
Well, you would have thought I suggested tripling the capital gains rate. That asset-allocating, buy-and-hold crowd turned on me like Glenn Beck at an Acorn rally. "That's market timing;" "It's speculating;" and it "undermines the financial plan;" are but a few of the heresies I apparently committed. It was at that point I realized Modern Portfolio Theory had moved way beyond an investment strategy, approaching near religious status, with Roger Gibson as its patron saint. I was lucky to get out of there with my assets undiversified.
Ten years and a couple of market meltdowns can certainly change people's perspectives, can't it? These days, advisors are questioning the wisdom of statically diversified client portfolios like never before. That's because we haven't seen times like these since the Great Depression. The $64 Trillion Question (you know, a trillion here, a trillion there...) is what will financial planners do instead of periodically rebalancing buy and hold portfolios? The leading candidate du jour appears to be "buy and harvest," which makes sense to my client-rewarding mind, and this new-found risk consciousness may just be the silver lining to this whole darn mess. But advisor beware: the financial industry has never lacked for folks who claim to reduce or even eliminate market risk. Finding truly lower risk strategies is a lot harder than it is enticing.
This past October 1, Jeff Cox wrote a story on CNBC.com titled "Bye-Bye to Buy and Hold" in which he proclaimed: "The time-tested buy-and-hold investment mantra has become so unpopular that even those who advocated the strategy don't refer to it by that name anymore. Now terms like 'buy and harvest'...have replaced the old philosophy."
Cox then went on to quote John Buckingham, chief investment officer at Al Frank Asset Management, in Laguna Beach, California, who includes his firm in the buy-and-hold camp "sort of." That "sort of" means Buckingham is a long-term, value investor, but with the flexibility to "follow the money," or as he puts it: "buy-and-continue-to-monitor." Which makes him a buy and harvest guy.
I had a chance to catch up with Jeff Montgomery, the CEO of Al Frank AM. Jeff's been around almost as long as I have--including stints as CEO of NFP Securities, and as CEO of ING's Washington Square Securities--so we had a great chat about the industry's past, present, and future as we old guys like to do. The firm he now heads was built on the success of The Prudent Speculator, an investment newsletter launched in 1977 by the now deceased Al Frank.
Montgomery added some anecdotal confirmation of Cox's asserted demise of buy and hold: "I've given talks to about 3,000 financial planners in the past two weeks," he told me "on their current approaches to portfolio management. I'd say conservatively that about two-thirds of them have a "buy and harvest" mentality; meaning they're either currently doing it, or embrace the strategy and are in the process of converting to it."
Now, anyone who knows financial planners also knows that they tend to be like a herd of cats: two-thirds of any group of planners agreeing on anything (beyond today's date, which might even be a stretch) is an astronomical number. As value investors, Al Frank Funds already lean toward the buy-and-harvest mentality, so I'm guessing that any group of advisors who goes to hear Montgomery speak is already skewed in that direction. Still, it's a big number, considering that just a year ago, the buy-and-holders would probably have comprised 90%.
As Buckingham suggested, "buy-and-harvest" essentially means buy and hold until the asset appreciates, and then take some of the profits. The theory is that as assets appreciate, they increase the risk of becoming over priced. So, a portfolio's risk is reduced by selling some of those assets, and buying less risky "under priced" assets.
Yet, we should keep in mind that what stock investors such as the Al Frank folks mean by "buy-and-harvest" is to invest in, say, large cap value until that asset class appears to be overvalued, then sell part of that position, and buy small and/or mid-cap value stocks. In practice, that may sound an awful lot like buy-and-hold advisors, rebalancing their client portfolios each quarter by selling out some of the larger asset classes, and buying more of the under-performing classes. The difference is the conscious monitoring of relative value vs. the automatic selling of whatever class happened to grow faster.
So, when the bottom fell out of all asset classes (save Treasuries) last Fall, advisors' regular rebalancing strategy didn't save most clients from taking that precipitous 50%+ drop. But the Al Frank value-oriented fund owners had less far to fall, and consequently recovered faster: It's flagship Al Frank Fund was off "only" 29.87% in the 12 months ending June 30, 2009, but up 8.37% the first half of 2009, double its Russell 3000 bogey.
Here's the key point: To "harvest" their profits, the Al Frank guys move money between three equity classes. Determining their relative values is a complex, yet finite, proposition. And because their universe is limited, their investors, while losing less than some other equity investors, still took a pretty hefty hit.
On the other hand, advisors looking for ways to better manage market risk are potentially dealing with the entire investment spectrum, a daunting task for folks who, for the most part, have little or no, formal training in economics or investment management. Advisors attracted to a "buy and harvest" strategy, are faced with questions such as: How do you decide when to take some profits off the table? And where do you put those "profits" so that they truly reduce the risk of another across the board market meltdown?
Financial planners typically allocate client portfolios between stocks (in mutual funds), bonds, and cash. In the past, gold, real estate, and oil have also been included. Yet, even if independent advisors in their relatively small shops could figure out a way to economically monitor portfolios containing all those asset classes, the bigger problem is that every one of those classes except cash fell like a stone last fall.
So where does that leave independent advisors? As far as I can see, they have three choices: Continue with the buy-and-hold static allocation approach, leaving clients to deal as best they can with the full force of market volatility; or embrace one of the growing number of market-timing strategies which attempt to avoid market downturns by moving into cash when things appear risky (and possibly hedging or increasing that "bet" through the use of short-selling vehicles); or mitigating at least some market risk through managers such as Al Frank Funds, who try to identify excessive risk (by whatever metric they choose) and move assets away from it, into lower risk alternatives.
Today, it sure seems Cox is right, and the old buy-and-hold may truly be dead, if only because the investing public has lost confidence in it. If the sordid history of tax shelters, limited partnerships, annuities, junk bonds, and international investing has taught us anything, it's that even the best advisors usually falter in the face of overwhelming public demand or aversion. And that leaves either market timing (tactical allocation) or mitigating risk, which is essentially strategic allocation. For my money, being in the market with less risk is better than being out of the market and adding the risk of missing out on the rides up; as did the folks who were in bonds for the last six-months' 60% equity gain.
Oh, and there's also my strategy of taking money off the table for things that just make clients happy. When you buy something you like you eliminate all the market risk. You can't expect people to put off all their fun until they retire: what if we don't get there? Besides, it sure seems that now would be an excellent time to buy that vacation real estate. Talk about buying low.
Bob Clark, former editor of this magazine, surveys the advisory landscape from his home in Santa Fe, New Mexico. He can be reached at firstname.lastname@example.org.