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Portfolio > Portfolio Construction

Bear Market Portfolio Insights and Tips for Anxious Advisors

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What You Need to Know

  • Years of easy returns have left many advisor-driven portfolios out of balance and ill-positioned for an eventual market recovery.
  • While investors are feeling significant pain in 2022, the current moment in the market also has its silver linings.
  • The economy is not the market, and this fact matters as much as ever in late 2022.

As a senior portfolio strategist at Janus Henderson Investors, Lara Reinhard spends much of her time speaking with financial advisors from across the Unites States, working to understand the way they build client portfolios and respond to emerging challenges.

Reinhard says she enjoys the work because of the product-agnostic angle her team can employ, and because she engages in constructive dialogue with so many skilled and dedicated financial advisors.

Over the years the portfolio strategy team has been in operation, Reinhard tells ThinkAdvisor, the group has analyzed upwards of 17,000 distinct advisor investment models, finding both significant degrees of uniformity and divergence across the industry. Overall, Reinhard says, the discussions with advisors show many of them feel like they are operating on an island, with surprisingly little insight into what their peers and competitors are doing.

In the Q&A dialogue presented below, Reinhard offers some key portfolio construction insights for advisors, including some specific suggestions for how to understand and respond to the current moment in the markets. As Reinhard explains, slowing growth, increasing inflation and significant market volatility are challenging advisors and creating concerns for clients.

Fortunately, Reinhard says, the current moment in the market also has its silver linings, and advisors can take steps today to position their clients for better days ahead.

THINKADVISOR: In your ongoing discussions with financial advisors, what kind of concerns are you hearing about most often?

Reinhard: What we hear the most, and this is true going back well before the current market drop, is that so many advisors feel like they are on an island, which I think some people would probably find surprising from the outside. What I mean is that many advisors don’t have a great sense of what their peers in other firms or regions are doing in terms of developing investments and managing their clients’ assets.

We also see a lot of cases where advisors are, say, based in a firm that has a well-defined approach, but they see themselves as doing things differently than their peers and colleagues — and that makes them feel uncomfortable. There are a lot of advisors out there today who feel somewhat uncomfortable about their approach to investing because they are not just adhering to their firm’s prescribed approach or guidance.

For advisors in this situation, getting some additional visibility by speaking with us is a meaningful thing for them. We can give them assurances that, for example, many of their peers also have a strong home bias in their equity portfolios. This home bias is something that is very common right now in the U.S. advisor community, and it’s starting to be a point of focus.

What are advisors telling you about the volatility they are experiencing in client portfolios? How concerned are they?

There is obviously a lot of concern and discomfort at this moment. Just like their clients, we see a lot of advisors feeling compelled to want to do something to respond to this moment. They want to make changes to show they are being proactive and that they are trying to help their clients.

Frankly, there’s not necessarily a lot that advisors can do right now. We do recommend that they engage with us and our portfolio management peers, to make sure everything is indeed in line. The advisor can then go to their clients and offer some reassurance that they have undergone a portfolio review and that they have confidence that things are on the right track.

On the bright side, while the history of the S&P 500 Index tells us there is likely more pain to come, it also tells us that patient investors have historically experienced more upside than downside over the long term. Since 1939, every time the S&P has crossed the 20% loss threshold into bear market territory, additional downside usually occurs.

In fact, inclusive of that drawdown, the next 12 months have resulted, on average, in a positive gain of 15% and a full recovery has always occurred within four years. In our view, we have now reached the point where investors should view the current landscape as a blank slate and seek to take advantage of new opportunities.

What are some of the ways in which advisor-driven portfolios could be improved?

As I mentioned, one very common theme we have seen in the past several years is a rampant home bias within the equity portfolios that U.S.-based financial advisors are building.

Once again, advisors are like their clients in this respect. They live here in the U.S., and they understand the companies and the market that exists here, and so they feel more comfortable investing here and owning the companies that operate here.

It’s really interesting because, in our collaboration with our global portfolio strategy team, we have seen that this bias exists pretty much everywhere that advisors are doing their thing and building portfolios. We see it in the U.K., for example.

Interestingly, this bias has actually helped U.S. advisors in the recent past, because companies here have delivered a good return over the last five years. What we bring to these advisors is a reminder that this bias exists and that it won’t always pay off, and that global diversification remains incredibly important over the long term.

We can help demonstrate this by showing the drag that the home bias has caused for advisors in the United Kingdom. So many portfolios over there in the U.K. are overly concentrated in a home equity market that has not returned a lot over the past five years, and the same could happen to U.S. advisors in the future.

Given the common occurrence of home bias, do you find that a lot of advisors build portfolios in similar ways?

While there are certainly some people on the fringes, it is actually quite surprising just how in line with each other most advisors are. I will share with you one telling example.

Here in the U.S., most advisors do have a home equity bias, but they also recognize that they need diversification, so they have maintained an international sleeve in their client portfolios. It is common today to see that this international sleeve, thanks to the way international stocks had behaved heading into 2022, has been overly concentrated into the growth category. This is because, obviously, international growth has meaningfully outpaced international value.

While we aren’t going to come in and tell all these advisors that they have the wrong allocation, we do ask them to think carefully about how their portfolios may have drifted over time. We ask them, why are you holding this international mix and how did you get here? Was it intentional, or are you now holding a portfolio that has drifted substantially?

We help them to see how important this is by showing them how international growth sold off right alongside the U.S. during the course of this year. International value stocks, on the other hand, have held up better.

What trends are you seeing on the fixed income side of advisor portfolios?

First of all, we find that most advisors just continue to gravitate towards thinking and talking about equities. They are more fun, I think, and they are easier to control, trade and understand. Unless an advisor is coming from a specific fixed income trading background, this side of the portfolio is a lot more confusing and difficult to manage.

At this moment, we are encouraging advisors to think about the goals for their fixed income portfolios. There are a few possible goals to discuss, but in our view, far and away the main goal should be defensive. In other words, your clients should own bonds because they need something to do well when equities sell off. If you were truly an all-out, aggressive investor with no protection needs, you probably wouldn’t want to own any bonds.

What we tell advisors in our framework is that, no matter how bullish you are about the equity markets, it makes sense for half of your fixed income allocation to be defensively oriented.

What are your expectations for what happens next in the markets?

Looking forward, the macroeconomic concerns are shifting from being concerned about inflation outright to being concerned about what is going to happen with growth. We all can see how much discussion is occurring today about recession odds and what will happen.

Our basic view is that this noise is not overly helpful for advisors and their clients, in part because it is our job, not theirs, to be that deep market expert. Also, they need to keep in mind that you can still get positive portfolio returns in a recession. It’s the classic lesson: The markets are not the economy. The markets are a reflection of forward-looking expectations and sentiments. Even advisors forget about this sometimes.

The question now is, are we pricing all the forward-looking concerns in accurately and approaching what will effectively be a bottom in the market? It’s possible. The recession may not hit until next year, but that will be when people are reinvesting in the markets.

What tips would you share with advisors with respect to adjusting portfolios at this moment?

With fixed income, start with duration. Start with duration by shifting your focus to empirical duration. Theoretical duration, which is commonly found on a strategy’s fact sheet, often overstates real-life interest rate sensitivity. Empirical duration, on the other hand, estimates a bond’s reaction to Treasury yield changes by incorporating real-life market risks. Strategies with lower empirical duration have the ability to weather a period of rising rates better those with more duration sensitivity.

Next, factor in yield. Strategies with relatively lower empirical duration and higher yield are positioned to perform better in high inflationary environments. Finally, incorporate risk.

On the equity side, it may be time to consider returning to a more risk-on posture. What we know pretty certainly moving forward is that rates aren’t going to be zero again any time soon. So, you have to bring a quality lens to your growth investments and keep your focus on companies with good balance sheets. If you have companies that have higher margins and less leverage, they can be expected to operate better when interest rates are higher.


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