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Building a Door

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There’s a famous Milton Berle quote that goes, “If opportunity doesn’t knock, build a door.” The famous comedian’s quip is meant to be funny, but it holds a surprisingly strong element of wisdom for the investment advisor. In challenging times, finding opportunity may necessitate a different approach. The market correction of 2000 through 2002, and less robust equity market returns (as compared to the 1990s) of today, have created an environment in which advisory firms can no longer solely count on increases in revenue from the appreciation of client assets. And advisors are taking heed as they “build their doors” in a variety of ways–including using alternative investments and adjusting their investment styles to be more opportunistic.

Looking at Alternative Assets

The equity market correction and more recent environment of lower real returns from traditional asset classes have forced great changes in how advisors manage money. Investing in traditional asset classes such as equities and fixed income may not generate returns sufficient to meet client goals. Many advisors are turning to non-correlated assets and alternative investments to boost performance for their clients (see Chart 1 below).

Alternative products–such as exchange-traded funds (ETFs), hedge funds, mutual fund turnkey asset management programs, and separately managed accounts–saw increased use across the board in 2004 as a challenging market made the potential opportunity offered by alternative product structures more attractive. Use of fee accounts, specifically separately managed accounts, jumped to 60.6% in 2004 compared to just 50.2% in 2003. Hedge fund usage grew sharply as well, with 43% of advisors investing in hedge funds.

ETFs enjoyed the most significant growth in the past year. This comes as no surprise. Last fall, the Rydex AdvisorBenchmarking survey revealed that advisors increased their use of this product the most over the past five years. In fact, the percentage of RIAs using ETFs jumped 40% from the previous year (42% compared to just 30.7% in 2003). ETFs also comprise nearly 7% of assets for the average RIA. As wrap minimums and fees decline, advisors increased their use of “mutual fund wrap” accounts with 11% of financial advisors using this investment option, which represents 4%, on average, of their total client assets.

Let’s Get Tactical

Advisors are getting more active in their investment style. Nearly 40% of advisors surveyed indicated that they were “tactical asset allocators” or had “become more tactical” in the past year. Most of those “tactical” advisors still create long-term strategic asset allocation targets for clients’ portfolios, but also make periodic adjustments for the asset mix based on short-term market adjustments. In 2003, 7.57% of advisors claimed that they became more tactical. That number doubled in 2004, with 15.62% of advisors declaring that they had become tactical (Chart 2).

Managing Expectations

Perhaps the biggest opportunity for advisors is in managing investor expectations. In June, Rydex surveyed 500 individual mutual fund investors–half of which use advisors for at least some of their portfolio. We asked about their expectations for their portfolio over the next decade and were surprised to learn that more than 70% believe that they will get 8%-plus annualized returns for the next 10 years, and 17% believe that they’ll earn 15%-plus annualized returns for the same time period (see Chart 3). Compare these expectations up with advisor expectations of the market and you’ll see a large disconnect. According to our AdvisorBenchmarking survey results, the majority of investment advisors surveyed (85%) thinks that the S&P 500 Index will increase 6-10% annually over the next three years.

Building Your Door

Granted, 2004 was a good year for the investment advisor industry. AUM, profit margins and revenues all rose. But in a market of harder-to-find performance returns, opportunity can be more elusive. Make sure it finds you by taking a few steps to build your door. If you haven’t already, consider broadening your investment expertise in some of the alternative investment options mentioned above. Our research indicates that most “tactical” advisors take advantage of continuing education programs and attend seminars to increase their knowledge base. IMCA offers a certification in the use of alternative investment products through the Alternative Investments Certificate Program. Finally, stay close to your clients, and discuss their expectations and the current market environment to make sure they’re aligned.

face=”Arial,Helvetica,Geneva,Swiss,SunSans-Regular”>Maya Ivanova is

a research analyst with Rydex, an affiliate of

Rydex Investments. She can be reached at

href=”mailto:[email protected]” mce_href=”mailto:[email protected]”>[email protected].


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