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Private Clients Piggyback on Institutional Approach

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Peter Tomasch of CapGroup Advisors has been using international diversification as a mainstay of client portfolios for years, and says that the firm’s large proponent of institutional clients offers the opportunity to provide the same approach for private clients.

With its recent increase in international exposure, CapGroup now invests about 40% of client money in the international arena. It also isn’t shy about taking advantage of the services it uses on behalf of its institutional clients—who make up about 70% of the client base—to benefit its private clients, too. According to Tomasch, that institutional approach is the reason the international allocation is higher than at many other firms.

“Our firm is unique in that we have more institutional dollars under management than private clients—[we manage approximately] $1.2 billion total—and about 70% of that is institutional, with the remainder being private client or family money,” said Tomasch. “Because of that size, we take an institutional investment approach and scale it down for private clients.”

One of the benefits of the firm’s scale is its ability to leverage resources that aren’t generally available to individual clients, such as its use of Mercer Consulting. “Mercer is the largest institutional consultant in the world, with billions under management and trillions under advisement,” Tomasch said.

Some of that broader outlook includes the view that “the world is equally divided in terms of market cap: about 50% in U.S. or domestic equities, with the remainder in international. If you’re going to be truly diversified, you’d have equal weighting to international and domestic, just from the standpoint of how the world looks.” Tomasch said that makes a lot of people think that that’s the right starting point for a portfolio. “Some institutions [regard it that way,] and Mercer does.”

The firm has models based on four different asset classes: traditional domestic equities, international equities, fixed income, which can include traditional or muni bonds, “or even high debt or international”, and a nontraditional/alternatives model that can include commodities and hedge funds. “We see the world in those four spectrums and work with clients to align those four modules to their risk tolerance or long-term goals and strategic plans,” said Tomasch.

With that institutional approach, he said, the perspective is that more should be invested in international because “these developed international stocks and companies are a little further behind than the US. in terms of recovery, especially the eurozone; we think about three years behind the U.S. in terms of recovery,” he said. “Domestic equity prices climbed, but not as much in developed international stocks, and we want to take advantage of that and take risk off the table for the massive run up we’ve had here at home.”

Getting past the home-country bias, he said, “regardless of what country you’re in, is one of the behavioral aspects” of investing. Fortunately, however, Tomasch said that with clients on the private side, “it’s very seldom you run into someone who doesn’t understand [the need to invest internationally] or doesn’t think it’s a good idea.”

The firm has exposure to emerging markets, which makes up “typically 20–25%” of international investments, and rather than relying just on one type of investment it makes use of a combination of ETFs, mutual funds and ADRs. For private clients, it tends to be more mutual funds, ETFs and separately managed accounts.

Currency risk is something advisors need to be aware of. Tomasch said that the strength of the U.S. dollar over the last few years has been almost like “a headwind over international returns.” He pointed to Japan’s stock market in the third quarter as an example. Q3 returns, he said, were “up 5.8%,” but when those returns were calculated as U.S. dollar-denominated, they came out as “down 2.3%.” The alternatives module the firm uses takes currency risk into account.

One other point that Tomasch raised concerned active vs. passive investing. “The U.S. has the largest, most well established and transparent stock market in the world,” he said. “In terms of the efficient-market hypothesis, the U.S. market is the most informational efficient stock market in the world. We are 50% of the total world market cap and because of that our companies are the most well covered by financial analyst and accountants in the world. Because of this, it makes sense to stay mostly passive in U.S. markets while employing active managers for international investments, particularly in less-covered countries or markets.”