This is a time of uncertainty. Given the events of the past several months, it’s unclear what will happen next–socially, politically, or economically. One thing that is perfectly clear, however, is the need for security: for the individual, for the nation, and for the portfolio.
To most advisors, this isn’t new: we’ve always been in the security business. But over the past several months, something has changed. As markets slide in the wake of political events and gloomy economic forecasts, clients have changed the way they think about their portfolios. No longer are investors thinking about performance when they talk about their investments: They’re talking about protection. Far from a bad thing, this “security crisis” presents an extraordinary opportunity for advisors to demonstrate value to their clients. By positioning yourself as a security expert, you can protect client wealth and build your business during uncertain times.
Talking about Security
Certainly, security means different things to different people. But in the context of our roles as protectors of client wealth, security means protection from forces that threaten the capital and, by extension, the quality of life of our clients. Right now, the most obvious threat to capital is the market itself: without effective defensive strategies in place, volatility can decimate a portfolio, and leave clients without the means to pursue life goals. But capital can be threatened by any number of forces: the taxman, creditors, inflation, and so forth. This means that whenever we discuss financial security with our clients, we need to talk broadly, and speak not only about investment strategies, but also tax planning, estate planning, and other issues.
This is particularly true when dealing with high-net-worth individuals (HNWIs). Simply put, the large portfolios and complicated financial arrangements of the wealthy demand a multi-faceted approach to financial security. This means we have to be more skilled, knowledgeable, and aware of security issues. What follows is a brief overview of what I consider to be the three things every HNWI should be doing right now to protect capital. Cover these three points and you’ll be well on your way to securing the long-term financial security of your clients.
Strategy #1: Alternative investments
I’ve seen a lot written about alternative investments lately, and it’s easy to see why. While the S&P 500 posted an 8.2% loss in September, for instance, the Tremont hedge fund index largely held its own, posting a drop of only 0.8%. Given the current investment climate, that kind of protection is something every HNWI needs to take seriously.
The economic expansion of the late 1990s resulted in an explosion of alternative investments. The 2001 edition of the Merrill Lynch/Cap Gemini World Wealth Report estimates that there was approximately $261 billion in hedge funds in 1996; as of 2000, that amount had grown to over $400 billion. Private equity has grown even faster: there was $45 billion invested in private equity funds in 1996; as of 2000, there was $163 billion. This growth means there is now a specialized hedge or private equity fund for almost every situation imaginable.
But while there are now more choices than ever, not all of them offer security in the true sense of the word. When it comes to security, alternative investing comes down to one thing: correlation with standard investment classes. Ideally, an alternative investment will offer non-correlated or negatively-correlated performance (two different things) when compared to a traditional asset benchmark. Such an investment can anchor other sections of the portfolio in volatile times, and help your clients achieve higher returns at a lower level of risk. Sounds good in theory, but not every alternative investment offers such performance. Make sure to consider historical returns of any alternative investment alongside market benchmark returns before you make a recommendation (see chart on right).