Choose Your Strategy for Wealth Preservation

There’s not a client today who isn’t concerned about wealth preservation, and astute financial advisors are nimbly helping investors meet this critical need. Indeed, since the global financial meltdown, clients have shown greater awareness and sensitivity to protecting their assets.

“I’ve yet to meet any family, regardless of portfolio size, that isn’t focused on preserving wealth,” says Michael Swenson, managing director, Swenson Jones Associates, in private banking at Merrill Lynch. His group, based in Wayzata, Minnesota, works with an ultra-high-net-worth clientele.

But asset preservation isn’t a simple matter in the face of current and projected stepped-up market volatility, rising interest rates (finally) and clients’ conflict over the pressing need to fund their own retirement versus wanting to leave money to succeeding generations. Among advisors, there seems to be little consensus as to which objective is the top priority.

On one hand: “Preserving wealth for your own retirement has definitely gained precedence. In 2008–2009, a lot of clients were very focused on leaving money to their kids and grandkids. All of a sudden, they got very focused on: ‘I need to make sure our own needs are taken care of first’,” says Carol Schleif, chief investment officer of the Midwest region at Abbot Downing, a Wells Fargo business serving ultra-high-net-worth clients.

On the other hand: “In most family structures that I’ve dealt with, transferring assets to family members in the future has a higher focus that it did 15 or 20 years ago,” Swenson says.

Whatever the prevailing chief goal, wealth preservation is clearly a top-of-mind issue; and to address this, it’s essential for risk management to be at the core of each strategy.

“If you don’t plan for things that can blow up your finances, it doesn’t matter if you’re beating the S&P 500,” says Mary Brooks, managing director of Integr Wealth Management of Raymond James, in Walnut Creek, California.

Alternative Methods

The most effective strategies require tough tradeoffs. The prevalent approaches that FAs are putting into play include alternative investments, annuities, life insurance, long-term care insurance and increased use of liquid assets.

“We’ve created a new set of investment objectives that are predicated on all-liquid assets,” shares Schleif, based in Minneapolis. “We have clients who don’t want any hedge funds or private equity — they want to be able to get money when they need it.”

For clients with a large exposure to the equity markets, paying attention to upside-downside capture is key.

“We look at outside managers who’ll participate on the upside but who are much more protected on the downside. We’re willing to give up some upside to make sure that swings are smoothed out,” says Mark Donohue, managing director, wealth management, the Donohue Group at Morgan Stanley in New York City and managing assets of about $1.2 billion.

Employing alternative investments as a third asset class can work well. They help to diversify and protect against volatility, and can also be used as replacements for bonds.

One such alternative is a global macro strategy, which seeks to capitalize on the impact of movements in various asset classes or segments. It looks at stock, bond, currency, real estate and commodity markets worldwide, going long or short and utilizing futures and options, according to Anthony Valeri, investment strategist with LPL Financial in San Diego.

“We’ve been using global macro strategies in some portfolios for just over a year now [instead of] bonds to provide diversification and potential downside protection,” Valeri notes.

“Investors need to be aware, however that [such] alternatives reduce potential upside. They’re designed for risk mitigation, not capital appreciation. So if you’re in a really strong equity market, these strategies likely won’t keep pace with stocks by themselves.”

Investing in alternatives that are non-correlated to the stock and bond markets is “a big part of wealth preservation. You need to [structure investments] so there’s a yin to the yang,” Donohue stresses.

Some advisors are recommending alternative strategies that institutions have long provided to pension and endowment funds. They can be a savvy choice in light of the expected drop in bond values resulting from rising interest rates anticipated over the next few years.

Seeking Stability

To generate income in retirement, some advisors are moving to utility stocks and master limited partnerships (MLPs), while at the same time, being selective in bonds.

“There’s a big transition of baby boomers from the equity markets to fixed income based on the need for income to support their [accustomed] lifestyle in retirement,” Donohue says. That transition is occurring partly because they “don’t want to maintain the risks in the equity positions they had in the companies they worked for.”

Last year, MLPs were beaten up by plummeting oil prices. Why does Donohue, for one, like them today?

“Whether MLPs are a good investment now depends on whether you believe that energy has bottomed,” he says. “Morgan Stanley is projecting crude to be in the mid-to-high $60s by the end of [this] year. So [MPLs] would be a reasonable thing [to buy].”

Though yields will be dragged by rising interest rates, bonds will nevertheless remain a primary source of income for many retirees and thus integral to the wealth preservation scenario.

“Bonds should not be abandoned even though they offer low yield. They work as important diversification [tools] and help protect against equity decline,” Valeri notes.

Further, bonds provide stability in the short term.

“We still believe in owning fixed income assets, but the type and structure of what we own has changed,” says Tom Sedoric, managing director-investments, the Sedoric Group of Wells Fargo Advisors, in Portsmouth, New Hampshire.

Sedoric is using a number of adjustable-rate bonds that “protect somewhat against rising interest rates,” he says. “Today we need to hedge both inflationary pressures in certain segments of the economy and deflationary pressures in others.”