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February 22, 2013 at 07:00 PM
Back in January, advisor Jeffrey Smith received an email from a relatively new client who was worried about how the debt ceiling negotiations and potential government shutdown might affect her portfolio.
Smith’s response was swift—and pre-emptive. He scheduled a face-to-face meeting for the next day and dispatched to all clients a letter he hoped would build a “sound and proper perspective” as events unfolded in Washington.
In closing, Smith, who heads North Shore Investment Consulting in Wilmette, Ill., cautioned: “Again, the media is going to have a field day with this. Try not to let it jar you. Should volatility emerge, throw a hard shoulder toward it. Portfolios need not, and should not, be de-risked as this event approaches.”
The tough conversations that dominated the advisor-client relationship during the 2007-2009 meltdown have not gone away. Far from it. Even though inflows into stock mutual funds and exchange-traded funds surged—finally—at the start of the year at the hands of suddenly bullish investors, advisors across the nation report what some are calling a historic pullback from stocks, and they are using words like “raw,” “shell-shocked” and “skittish” to explain their clients’ continuing malaise.
As Dan Carlson, chief financial officer of New York City-based Toroso Investments, puts it: “Something that’s not talked about a lot is that when we had the tech bubble blow up in 2001, everyone knew it was a high-risk environment. In 2008, it was my bank and my home that blew up. That’s a totally different psychological blow-up that people have to get over. That gets to the core of what a person’s emotional psyche can handle.”
Statistics paint a fairly bleak picture. A Gallup poll released last April—at a point when all three major stock indices were in a sweet spot—showed that only 53% of American households owned stocks, down from 65% in 2007. It marked an all-time low since 1998, when Gallup first began tracking stock ownership. More recently, in June, the Federal Reserve’s Survey of Consumer Finances revealed that stock ownership had slipped under 50% for the first time in decades.
Between January 2000 and the end of last year, individual investors pulled a net $900 billion from U.S. equity funds, according to EPFR Global. And while renewed enthusiasm over stocks created a lot of buzz in early 2013, market watchers say each of the last four years has started off with investors shifting money into U.S. stocks—only to do a U-turn. And many advisors, like Jeff Smith, won’t be surprised if the continued bickering on Capitol Hill causes already jittery clients to stay on the sidelines.
“Since the popping of the dot-com bubble, we’ve had the recession, the credit crisis, the flash crash, the IPO fiasco with Facebook, and now we’re looking at all this brinkmanship and rancor in Washington, D.C. This proverbial wall of worry is not going away anytime soon. I don’t think it ever will,” says Smith, a certified financial planner who manages $144 million in assets for 160 clients. “Sometimes, I think about getting rid of the table in my office and making room for a couch.”
Rethinking Stocks
The anti-stock sentiment has increased the need for hand-holding and educational outreach to clients, of course. But it’s also important to note that it is not just the client who is on a journey of reexamination. The advisor is as well.
For some, it has meant a dramatic shift from modern portfolio theory to other disciplines. Others are taking a look at self-directed retirement platforms that utilize alternatives like private placements, rental property and second mortgages. And many advisors, not surprisingly, have adjusted their own thinking at fairly basic levels as they rethink stocks through today’s lens.
“The trend in our practice is to emphasize sustainable fixed reliable income investments along with the equities. It used to be growth and income. It’s now switching more to income with growth,” says Victor Hazard, a CPA who heads Hazard Financial in Lomita, Calif. “A lot of clients are coming back and saying ‘I don’t want to take my wealth and double it every five or six years like I wanted to do in the past and what I really don’t want to do is have my wealth contract by 40% like it did in 2008.’ The middle ground is: Let’s get something dependable.” For Hazard, who has $105 million in assets under management, “dependable” translates to master limited partnerships, publically traded REITs and, on occasion, dividend-paying stocks.
Donald Cummings Jr., managing partner of Blue Haven Capital in Geneva, Ill., says most of his clients are reluctant to maintain anything above 60% in equity exposure today.
“Should advisors convince clients to have equity exposure? Absolutely. Should it be a sensible allocation that is in line with a client’s volatility tolerance? Absolutely,” says Cummings, whose firm oversees $30 million-plus for a few high-net-worth clients and small family foundations. “My question to clients often is: ‘How would you feel if equities dropped 40%?’ Actually, in most cases I am more conservative than my clients. They really have to wrestle hard for me to raise their allocation in stocks. We are seeing more volatility than ever and more periods of single- , double- and triple-year losses in the S&P in the last 10 years than in any preceding decade. Advisors need to pay attention to that. These are people’s livelihoods we’re involved with.”
Patrick Hejlik, CEO of Fourth Quadrant Asset Management in Danville, Calif., says getting clients to re-engage out of a cash position or fixed income instruments remains a challenge. “After 2008, they felt they’d been hit over the head with a sledgehammer,” he observes. “Trauma like that will wear on you for a long time.” Hejlik, a former head floor trader on the Pacific Options Exchange whose fledgling firm has $5.5 million in assets under management, says he has successfully coaxed timid investors back into equities by using options paired with a standard portfolio structure equipped with equities, exchange-traded funds and fixed income vehicles.
“When the governor says the hurricane is barreling across the coast and get off the beach, we don’t want to be that last couple boarding up the house and saying we’re going to ride it out,” says Fiorillo, who covers all trading costs for his clients. “If the market doesn’t decline as much as we think it will, all we are guilty of is not making as much money as we might have. It was very difficult to make such a philosophical change but 2007-2009 should have caused every advisor to re-examine everything they ever thought about modern portfolio theory and diversification. You don’t have to take whatever the market throws at you. My clients sleep better at night now, and as their advisor, so do I.”