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Portfolio > Portfolio Construction

Keeping the Faith

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Remember the old vaudeville routine where, in a bid to stretch credulity, the street performer challenges his audience with the leading statement, “It was so bad…” And the audience dutifully shouts out, “How bad was it?” To which the performer, milking the suspense, shouts back, “It was sooooo bad…” And so on. Well, with a downhill market exacerbated by corporate scandals rocking investor confidence, how bad is it, really?

How have the perception and reality of the current financial climate–perception often differing from reality–affected clients and their relationships with advisors? What are advisors doing and saying to ensure that their charges stay the course and keep the faith?

Allowing for varying degrees of financial acuity, a relentless media bombardment has made investors thoroughly aware of such fiscal faux pas as the following: that from the turn of the new year through July 31, the S&P plummeted 23%, the Dow dropped 16%, the Nasdaq fell 31%; and that 93% of mutual funds reported negative returns in the second quarter of 2002. The media, too, have been trumpeting the fact that the market has not experienced three straight down years in more than 60 years. Investors sense that, barring some miracle, this record will fall at year’s end.

Two surveys of readers by Investment Advisor in August (one a general survey on advisor attitudes to which 331 readers responded, the other a more focused survey to which 54 readers responded) found that advisors feel more pressure these days, and that many have seen changes made to client’s portfolio allocations, including more interest in fixed-income investments. In general, however, the survey results, amplified by conversations with a range of financial advisors across America, show that while some advisor clients are apprehensive and approaching the limits of their maximum loss tolerance, others have adopted a “What, me worry?” attitude, leaving all the nail biting to the advisor. There are also those clients who have become involved in the planning process with an intensity normally reserved for other pressing life matters. Scott Agnew, a 10-year planning veteran and principle of Ascent Capital Management in Bend, Oregon, reports that the level of involvement exhibited by his clients is double what he has ever experienced before. His clients are seeking and demanding “much more active management” as well. Agnew’s average larger clients (those with assets under management of more than $750,000) now contact him at least once a week. “I have clients call and say, ‘Hey, I notice our two real estate funds took a nosedive. What happened?’” Just a few months ago the average frequency of communication with those same clients was once each quarter, around the time the firm delivered its quarterly reports to clients. A sample letter to clients can be found on page 60; letters posted by other advisors to clients during these trying times are available at

Let’s Do Lunch

The importance of “staying in touch” with clients cannot be overstated. Eric Park, president of Steamboat Financial Group in Washington, Missouri, maintains that crises can be avoided by staying in touch with each client. This does not mean his clients are blas? about market events and corporate shenanigans. “But a deeper, better understanding helps keep clients focused on their long-term goals,” he says, adding that it also helps to avoid “the confusion that builds with the manic-depressive popular press blanketing the TV every day.” Karen Paul of Paul Financial Services in South Burlington, Vermont, believes the only thing to do in this market is to keep communicating with clients. “If you communicate and clients feel your voice, you will survive this market. If you run and hide, you will not. It’s really that simple,” she says.

Adding to the demands of communication is the fact that clients no longer want mere advice, they want to know why they are getting certain advice, according to Agnew. Towards this end, many clients are quickly educating themselves. They’re reading up on and asking questions about everything from the specific funds and products in their portfolios to the advisor’s broad-based strategy. They’re clued into federal legislation and regulation and how the interest-rate decisions of the Federal Reserve Open Market Committee interest rates could potentially impact their fixed income portfolios, and they’re very cognizant of stock market performance conditions on the equity side. And while clients may be feeling considerable concern, Glen Buco, head of the financial planning division at Annandale, Virginia-based West Financial Services, says most of his clients are fairly confident that things aren’t “going to go to hell in a handbasket”–they don’t seem to have lost all faith in corporate America. They are intent, however, on not getting suckered again.

The most rational of investors may accept that the bubble had to pop some time, that the dire predictions of a sustained bear market have for nearly three years been bearing distasteful fruit. But it’s hard to be rational when your money is evaporating before you. “A lot of people,” says advisor Ron Pearson, “have a deer-in-the-headlights look.” Pearson, of Beach Financial Advisory Service in Virginia Beach, Virginia, finds clients often want to sell because their “gut” tells them to sell in the depressed and hyperreactive market they are witnessing. And more than ever before, clients are questioning what exactly it is that their advisors do for them. “Let’s get this straight,” Pearson posits on the typical querying client’s behalf. “I’m losing money and I’m paying you for the privilege?” When all is said and done, however, it falls to financial advisors to refocus clients’ attention in a more positive direction, while assuring them that it won’t rain forever on their investment parade. As advisor Mike Searcy of Searcy Financial Services in Overland Park, Kansas, says: “We don’t sugarcoat it but we do look for the rainbows at the end of the storms.”

The Right Perspective

So how bad are things? One of the first weapons advisors are using today in fighting off irrational client fear and behavior is perspective. “I feel like 50% of the value that I add to clients is putting myself between them and their money,” says Pearson. He does this in the literal sense, sitting down with clients in person or talking on the phone. He does it through education, endeavoring to reshape clients’ outlooks and expectations and steer them away from panic-induced, short-term thinking. If clients aren’t already aware, he provides them a short course on the state of the markets in 1973 and 1974. What he tells clients–and writes to them in his newsletter–goes something like this: In November 1972, the S&P 500 hit 116, only to fall to 63 in September 1974. This drop over two years nearly matches the current drop (1517 to 850) in percentage. “Look,” he will say, “we had Watergate then, the Vietnam War, the Mideast war, oil embargoes, and inflation was high. You don’t think there were doom and gloom headlines then? It was awful. Frankly, if you decided to enter the market at 116 in 1972, it was 1982 before you got back to break-even. But if you hung in there, 30 years later, you’ve got yourself a 700% return.” What’s especially important in terms of perspective, he stresses to clients, is that when you look back today at that huge drop in 1972 and 1974, “it’s barely a blip. That’s what we’re going through now.”

History Lessons

Sameer Shah of Shah Associates in Tampa, Florida, also escorts his clients on a trip through history, impressing upon them that the worst time to pull out of equities is when everyone panics and sells after a horrendous decline. He assures his clients that the market was overvalued and is coming back to normal. He reminds clients of the famous Business Week cover headline in 1981 that declared that equities were dead, noting that shortly thereafter they emerged alive and well in the form of a revitalized stock market. Real and reprehensible as the present corporate scandals are, Shah believes people may be overusing them as a scapegoat. “I think there is a bit of hysteria to this whole thing,” he says. “The fact of the matter is that markets go up and markets go down, and sometimes there’s no rational reason why.” Shah meets with clients on an “as-needed” basis, and while he’s handling many more phone calls, the current economic climate has not significantly affected his relationship with clients. “I would hope that the reasons for that might be that I’ve always been very open and honest, I think, in terms of what an advisor can and cannot do,” he says.

“They’ve been handling it okay, and they seem to understand,” says Pearson of his clients. Nonetheless, Shah, Pearson, and other advisors are engaged in more client handholding than ever before. The second survey of Investment Advisor readers in early August found that of 54 respondees, 47 are spending more time communicating with their clients. “This is not the time clients want to hear a black hole from their advisor,” says Pearson. He admits to logging an extra three or four hours a week on the phone and writing e-mails to clients explaining why their portfolios will look worse than the month before–and that they’re actually doing quite well relative to many others.

He’ll explain to clients that through the end of June a typical Pearson-run client portfolio was down 3% or 4%, at a time when the S&P was down 14%. Before the market went haywire, he will note, these portfolios had a substantial weighting in small- and mid-cap holdings, and a lot of that, maybe two-thirds, was on the value side versus the growth side. “Things were looking pretty good and I was beating the tar out of the S&P,” he says. Then, in July, everything but bonds tanked. “There was no safe harbor that month, and everything went down pretty near to the S&P.” He rushed out a newsletter to tell clients that, in effect, while their July statements were going to be pretty ugly–typically down five, six, seven percent for the month–for the year they were “still light years ahead of the S&P.” This is similar to the attitude advisor Glen Buco adopts towards his modestly stricken client portfolios. He says to clients: “Look, if we can take what is the second or third worst period historically and turn it into an average loss, then the outlook for the future is very good.” It can be a tough sell, however, when percentages are turned into dollars. “When you take a reasonable loss of 5% or 10% and multiply that times the size of the portfolio and see what the real dollars are,” Buco admits, “then people start to choke.” You talk it through, he says.

Many investors feel like they’ve been burned, or are gunshy due to losses, “but that’s when your ability to handhold and a knowledge of the client really comes into play,” says Buco. He, too, has logged much extra time with clients the past few months, setting up evening meetings and phone calls. Interestingly, he has discovered that clients who have the hardest time now are those trying to make major life decisions, especially retirement. “These decisions get a little bit harder when the numbers don’t look so good,” says Buco. While in general he recommends “staying the course” in regard to client portfolios, he endeavors to free the client from putting plans on hold. “I say we need to take a broader perspective and look at the situation, keeping in mind that we’re closer to the bottom of the trough than we are to the top.” In a similar vein, advisor Agnew says his biggest problems lie with clients over age 50 whose window to retirement is growing increasingly narrow. Many have asked him “over and over” to jump ship with their equities. “My main job is to try to get them not to make overly dramatic changes,” says Agnew. “But at some point, it’s their money.”

Silver Linings

The extra hours advisors spend with clients help cement existing relationships, and as busy as these advisors are, new clients continue to walk through their doors. “These are the times that my value really comes into play,” says Pearson, “and that’s one of the reasons I’m getting more and more business.” In 2000 he had $10 million under management; today, in a down market, he has $15 million under management. “One third of my new business has seen nothing but negative returns,” he says.

He’s not alone. Agnew, an independent advisor, has had a “surprising number” of new clients who switched over from some of the big wirehouses, claiming they didn’t feel they could trust their advice any longer. Agnew says clients have told him, “I owned WorldCom, I owned Tyco, I owned Enron, and now I don’t know why I owned these.” Agnew relates an experience, albeit somewhat extreme, with one of these new clients. “The man owned 42 funds, God knows why, and we noticed that over 60% of them were proprietary, and that the overlap on the equity side was upwards of 42%. So obviously allocation was nonexistent.” Two months passed from the time of their first meeting to when the man returned to Agnew’s office. He arrived carrying a brand-new briefcase; inside were his latest Principia Pro CDs and three fat books on the stock market, which he had read and highlighted. “I mean, this guy went to school because he was basically ashamed and pissed at himself for not understanding what was going on.”

Buco, too, has landed new accounts. “It’s been busy,” he says. These refugee clients have come from brokerages and other advisory firms, “where people were much more aggressive than they should have been,” he says. Other new clients, such as do-it-yourselfers, have found that they can no longer do it themselves, that “it just isn’t fun any more.” Buco has seen new clients who really should have been in lower equity allocations and others who have said they never would have bought bonds if it weren’t for him.

Staying Which Course?

It’s not always easy to stay the right course in terms of portfolio allocation when the client insists otherwise. Some clients may reach a point in terms of risk tolerance where the next thing out of their mouths is likely to be, “I’ve gotta bail.” But if a client truly doesn’t need immediate cash, he can usually be talked out of selling off. Here’s a fairly common scenario. Pearson inherited a client couple whose portfolio was 100% stocks, mostly technology. He reworked the portfolio to a 70% to 30% mix of stocks to bonds. “But they still have a lot of low-tax-basis Microsoft, Intel, Sun, and Oracle, and those have been hit pretty heavily,” Pearson says. Which is why the clients’ $3 million portfolio is currently at $1.75 million, and the clients are “feeling kind of poorly.” On the other hand, they’re drawing a livable $90,000 a year out of their portfolio. The point he tries to drive home to his clients is this: they have $90,000 in cash in their money market account and $300,000 to $500,000 in bonds that he could sell if necessary. He doesn’t have to sell stock low just to keep them in the kind of cash they need to maintain their lifestyle.

“What I do with these stocks is that as they go up I put a limit order in there, we trim a little off the top,” says Pearson. “Coke hits 60, I’ll sell 10%; if it hits 65 I’ll sell another 10%. We just cream a little off the top to keep the money market going, plus the bond interest. The clients say, ‘Okay, I don’t need the money today, not until years down the road,’ and we know the market’s going to turn around.”

When Staying the Course Is Misguided

Of course, in certain circumstances doing nothing is the wrong course. As Buco discovered, “a lot of people are beginning to find out right now that their risk tolerance isn’t quite what they thought it was.” Bring down the equity allocation–not too much–and don’t take them out [of equities] at the bottom, he preaches. The 300-plus respondents to our survey found that nearly 50% said their clients were shifting more of their portfolios toward bonds and cash, though more than 35% were not making any changes. “It can be tricky when you’re picking the best-of-the-worst kind of thing sometimes,” says Buco, “but for some clients I think that’s clearly a better situation to have than sudden panic and a desire to be out of everything. We don’t have much of that but if the market continues we might find we have more clients thinking that way.”

Here’s what a few other advisors have done in terms of portfolio makeovers, and concerns they have deliberated over. In the last month, Mason Dinehart, president of Financial Education Network Development in Los Angeles, moved over $2 million of client assets out of mutual funds and into equity index annuities, which provide a base of 100% of principal plus 3% guaranteed. With the downside protected, the upside is either the 3% or approximately 85% of the S&P 500 index, whichever is greater, he says. “I use products from ING and American Equity and the maturities are seven to nine years.” He feels these products are especially appropriate for older clients’ IRA’s because of the guaranteed downside protection. “They have unlimited penalty-free withdrawals for emergencies (nursing care and hospitalization) and 10% per year, normally,” Dinehart says.

For his firm’s younger and more aggressive clients, advisor Mike Searcy reports that he has used “this terrible market” as an opportunity to accumulate more shares in equities. Assuming the clients have adequate reserves, they don’t need to tap into the equities any time soon, he reasons. “They are in it for the long haul and expect that we will one day look back and say, ‘Wow, that was a great time to make some added purchases. I’m glad I did.’” For retired clients, Searcy’s firm has attempted to maintain four years’ worth of “safe” investments from which the client can draw during a bad equity market. The strategy is to have some of the portfolio focused on growth, he explains, which should help clients stay ahead of taxes and inflation while still producing a real rate of return. In addition, Searcy maintains at least four years of safe investments–such as CDs, laddered bonds and government bonds, and money markets that can be drawn down when the equity market gets hammered, leaving the equities alone so that they have an opportunity to recover when the market moves back up. The strategy has worked well so far with retired clients, he says. “However, we are beginning to approach a time where the ‘safe’ portion is getting smaller. Hopefully, we will see some improvement in the equities we hold before the safe reserve runs out.”

A respondent to our second reader survey said that the most difficult challenge today is compiling a list of good quality dividend-paying stocks that appear undervalued and are good investments, even if the bear market continues. Another challenge was searching for undervalued preferred and convertible bonds. The respondent expressed concern that current low interest rates eventually will rise, “so am confining most bond purchases to about five years or less.”

In a recent e-mail to this magazine, Todd Schoenberger of, an online provider of annuities based in Leesburgh, Virginia, quotes the industrialist Henry J. Kaiser: “Trouble is only opportunity in work clothes.” This is especially apt, as we’ve seen that for some advisors, tough times for consumers spell good, if tiring, times for them. More important, however, is the opportunity financial advisors–and the planning profession itself–have to “shine” through the gloom of current market doldrums and corporate scandal. “We doubt there’s ever been a time when your personal integrity is more valuable to potential clients,” Schoenberger says. Put it to good use.

Senior Editor Cort Smith can be reached at [email protected].


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