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Managing Wealth in a Post-9/11 World

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I cannot imagine how difficult it must be to be a financial advisor still clinging to the old axioms of wealth management in our post-9/11 world. Talk about a losing battle.

It has been a couple of years since I called out those advisors who insisted on “stubbornly standing by their man(tra)” of buy and hold investing, the efficient frontier and MPT in the face of compellingly irrefutable evidence of their errancy.

Old-school RIAs continue to rally their recollections and romantically reminisce about the resolute investor of the 1990s. Boggled by the conflicted wisdom of John Bogle, equity investors were unflappably rope-a-dope-able—fervently embracing “stocks for the long haul,” despite the ruthless markdowns of Black Monday (’87), the Asian currency crisis (’97), Russia’s debt default (’98) and the 2000–2002 bear market. Investors kept coming back for more.

But no more. Investors are now adopting a “fool me a half a dozen times, shame on me” posture—particularly the HNW and family office clients. Having already endured the so-called “growth” stock bubble in 2000, a nearly 60% decline in the S&P from 2007 through March 2009 and the one-day 9% “flash crash” in May 2010, there is not only less wealth to be managed, there are also fewer wealthy investors willing to be manhandled by advisors who continue to ignore the new realities of the equities markets.

Even the younger investors are not buying it. Cash holdings are at their highest levels since the record in March 2009 and a BofA-Merrill Lynch survey in mid-August pegged 18–30 year olds with the highest cash position (30%) of any age group. So don’t count on new money to replace old money.

Advisors who believe that they know better may be righteous—but the investors are right. Things have changed since 9/11 and advisors must adapt to survive. Over the past decade, the S&P has returned 1% adjusted for inflation. The Lost Generation of Investors that I predicted in a Venture Populist blog post in March 2009 has come to pass—people used to buy the dips; now they are selling the rallies and exiting the playing field.

Good timing, too. JPMorgan recently noted that the correlation between the movements of U.S. stocks is at the highest level since Black Monday as individual company fundamentals are no longer the primary driver of stock price. The historical average correlation is 30%. Today the correlation stands over 80%. The measure peaked at 88% during the October 1987 crash.

One of the primary culprits is high-frequency trading (HFT) by institutions and hedge funds that trade the broader market indices for short-term movements according to technical considerations and without regard for company fundamentals. A typical high-frequency trader owns a stock for just nine seconds. As columnist Jason Kirby recently noted, “The vast bulk of trades now involve no humans at all, but rather sophisticated computer programs that swap stocks at lightning speed.” Most believe that HFT was the primary cause of the flash crash of May 2010.

But a larger factor is in play that began with 9/11—unpredictable “macro” forces such as natural disasters, geopolitical shocks and systemic failures of other national economies and currencies. Now investors recognize that there is a distinct difference between measureable endogenous market risks and external uncertainties capable of extolling immeasurable devastation to the markets.

As the last decade clearly illustrates, none of this is conducive to long-term, buy-and-hold or fundamental, “know the company” investing once promoted by the likes of Peter Lynch. Moreover, even most of the conventional “alternative” investments no longer provide evidence of sustained non-correlation. Cash (and some bonds) is king right now—and are likely to be for the immeasurable future. True fundamental investing in a company’s long-term growth prospects has become the sole domain of some micro-cap stocks and direct private venture investment in early-stage companies.