The Changing Rules of Asset Allocation: Practice Edge, June 2009

If what goes up must come down, then the opposite must also be true: what falls down (even the market) must bounce back. Even a battered economy, no matter how far it has fallen, will eventually recover. But with many investment advisors suffering a loss of assets and tightening profit margins, some firms may not be well positioned to take advantage of the recovery when it does inevitably come 3/4 and a recovery may be not so far away. The Advisor Confidence Index, our monthly advisor confidence indicator, shifted into positive territory in May 2009 for the first time in the past year. The May index increase marked the index’s most significant upward movement in the last 20 months. “It is looking more and more likely that we will be out of recession soon, though it will not be officially recognized until probably next year,” said Bill Ramsay of Financial Symmetry of Raleigh, North Carolina.

The downside, however, is that according to the Spectrem Group, a Chicago-based consulting firm that specializes in the wealth and retirement markets, “anywhere from 20% to 30% of wealthy clients will change advisors over the next several years.” To ensure that your business bounces back with the market, it’s imperative to retain 3/4 and gain 3/4 clients rather than risk losing them to competitors. Helping clients weather the storm is essential to retention, so this month we take a look at how approaches to asset allocation are changing in today’s challenging market environment.

The Power of Asset Allocation

The majority of advisors say that their approach to asset allocation has changed in the last six months. More than 35% of advisors surveyed said that their diversification approach remains the same. Twenty-four percent of advisors said they are increasing their allocation to income-oriented investments such as bonds, real estate, and TIPs. About one third (33%) of advisors surveyed quickly reacted to changing market conditions by increasing their allocation to alternatives.

The Role of Alternatives

As markets become more challenging, advisors seeking to insulate client portfolios from market volatility are borrowing a page from institutional investors’ playbooks: they’re increasingly turning to alternative investments. Alternative investments and non-correlated investment products are playing an increasingly important role in advisors’ client portfolios to enhance returns and mitigate risks. Thirty-seven percent of advisors surveyed said they have increased investments in non-correlated products in 2008 and 26% said they have increased allocation to alternative assets. Nineteen percent of advisors surveyed said that alternatives played a significant role in helping protect their clients’ portfolios and mitigating their downside risk in 2008. Thirty-three percent of advisors said they are increasing allocations to alternatives to provide adequate diversification to their clients. Only 12% of advisors surveyed said that they used alternatives but that alternatives did not help the portfolios.

Investment Style