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Strengthen Portfolios and Client Confidence Through Open Architecture

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Too often, new prospects come into our office and, after we conduct a bit of fact-finding, we learn that they are in the same stock and bond portfolios that almost totally devoured their portfolios less than two years ago. When we see that, we wonder whether it’s the client’s fault for not changing his or her investment approach, or whether it’s the previous advisor’s fault for sticking with a sinking ship. Often, when there are any changes at all made in their portfolios, they are more akin to rearranging deck chairs on the Titanic than they are to changing ships altogether.

Our firm is an independent advisory firm with deep roots in the life insurance business, so we naturally lean toward a wealth management strategy that focuses intently on the preservation of our clients’ wealth. After the experiences of the past couple of years, we’re finding that our approach, which focuses on our clients’ total wealth management needs—not just their investment needs—is resonating well with people and is helping to separate us from our competitors.

We learned hard lessons during the past two years. One of the lessons is in how we position ourselves to compete in the market. With that in mind, we made the decision to dissociate ourselves from our broker-dealer. We are not recommending that our clients buy individual securities these days, but instead are focusing on preservation of wealth through products like fixed annuities and life insurance, private equity funds, hedge funds, managed futures, limited partnerships, and even real estate. In light of the frightening hit that the typical traditional portfolio has taken in the past few years, we’re recommending that clients start to look at the value that lies in working with a firm that has complete open architecture.

For us, the term “open architecture” describes an advisory firm that is flexible enough to truly serve its clients’ needs. It is not locked in to any approach, product, or investment class other than what is in the best interest of the client. Flexibility and adaptability are keys to this approach.

As an advisor and as an investor, you must be adaptable; the market, the world, and especially the solutions to problems in our clients’ portfolios are not always in black and white. The wave of the future is diversification through alternative asset classes. Traditional equity and debt portfolios do not offer the protection that our clients should demand, at least not the protection that we demand for them. Negative experience has shown that the correlation between equity asset classes is just not enough to provide an investor with the kind of diversification that will actually protect the portfolio. In other words, some people used to believe that not all stocks, bonds, and real estate could possibly lose value at the same time. Recent history shows otherwise.

There has been a lot written recently about managed futures, and no doubt many advisors are like us and have started to make good use of them in their clients’ portfolios. As we explain to our clients, managed futures is a business in which professional money managers direct investments in the global currency, interest rate, equity, metal, energy and agricultural markets. They do this through the use of futures, forwards and options. Because of the markets in which managed futures trade, and also because investing in this area takes a long/short trading approach, putting some money in managed futures may add substantial diversification to an investment portfolio. Potentially, managed futures can enhance risk-adjusted rates of returns, because managed futures’ returns have historically shown low correlation compared to stock and bond investments. Following modern portfolio theory, this lack of correlation builds the robustness of the portfolio, reducing portfolio volatility and risk without significant negative impacts on return. This lack of correlation stems from the fact that managed futures draw their returns from different sources than traditional stock and bond investments. Consequently, managed futures often can return positive returns while stock and bond markets do not.

Another asset class that we are recommending to our clients these days is private equity. Typically, investors in private equity have been only the very, very wealthy or, in some cases, people who have a special relationship with the private equity fund (for example, key employees in a firm that is owned by a private equity group). But we have discovered that some private equity firms that are seeking new funds are very open to the idea of smaller levels of investment and we are partnering with some of those private equity funds to offer our investors a new opportunity.

Another opportunity we’re offering in alternative investments is in hedge funds. For many of our clients, the very words “hedge fund” cause them to tremble; in the minds of many clients, the term is immediately associated with high risk. This is an area in which we do lots and lots of teaching, and we stress to our clients that associating the term “hedge funds” with risk is no more accurate than associating the term “IRA” with risk. Hedge funds and the investments contained within them offer investors the world, and, of course, will often have some potential for significant risk in exchange for the potential of great return. But we believe that just as often they offer an investor security in an alternative asset class that can protect against catastrophe.

Just as there are opportunities for smart, safe investment in private equity and hedge funds, there are opportunities in limited partnerships as well. We have found that this is an area where it is critically important to be well-connected in your community so that you are able to take advantage of opportunities that typically are not well-publicized. We have found that our weekend radio station has brought us the credibility that helps us stay connected to the local business community, and that has helped us help our clients take advantage of opportunities that they otherwise would never have heard about.

We stress to our clients that one of our roles is to bring financial opportunities to their attention. And another of those opportunities is in real estate. Here again, the most common reaction to the suggestion that there may be opportunities in real estate is fear, fed by the never-ending negative reports on the state of the real estate market. But what we explain to our clients is that negative circumstances do offer opportunity for those who have liquidity. For example, we tell our clients that it isn’t a question of them losing money in the real estate market if they have the liquidity to hold property long enough to make money. Obviously, that’s not the case in the stock market, where we now know that money can be lost no matter the time horizon.

And believe it or not, there’s good opportunity in real estate right now in our area. For example, we recommend that our clients consider buying developed lots that builders have turned over to their banks. Again, many of these opportunities are not well-publicized, and they take a considerable amount of networking and relationship building to be able to uncover and package for your clients.

But that’s what will separate you from your competitors—being a firm that has complete open architecture and that is truly looking out for your clients’ best interests.

Arnold Bennett, the famous novelist and playwright, once said, “Any change, even a change for the better, is always accompanied by drawbacks and discomforts.” This is true when you’re talking about changing almost anything. As an example, for the first time in more than a dozen years, the managed futures market was down in 2009. But do not let small drawbacks dishearten you. Step outside the box, because you never know what you might see.
If you don’t start stepping outside the box, your clients may do so without you. In our more than 30 years in this business, we can say with near certainty that when we bring ideas to our clients, we keep those clients happy for much longer. After all, that is what they pay us to do.    

Bill Baer, ChFC, is chief executive officer and Kenny Baer is chief marketing officer with Baer Wealth Management in Marietta, Ga.


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