Advisors earn their money in turbulent markets. In trending bull markets, our clients are often too busy to meet with us or even to review their brokerage statements. But when markets are turbulent, they want our time and attention all at once.
Our business model allowed for these congested periods of hand holding during the secular bull market because we could always count on markets to bounce back and continue higher. There was no associated demand on our time to make tactical adjustments to client portfolios.
But following two major market meltdowns in the last decade, we now observe that many advisors are, at least to some degree, tactical, whether or not they are fully prepared to execute this new approach. They recognize that they must be tactical to prudently manage risk. Markets are moving too fast, volatility is too high and returns over the last decade have been disappointing. So instead of just backing clients away from the ledge in declining markets, now advisors must assess markets, make tactical adjustments to the portfolio, develop the appropriate messaging to clients and communicate with clients … all in real time!
That is a tall order. An emerging advisor with $50MM AUM and an average account size of $800,000 services about 63 accounts … all of whom reasonably expect their advisors to proactively reach out and assure them their nest eggs are safe when markets are turbulent. Assuming that advisor spends 1 hour per client preparing for the call, playing phone tag and spending some quality time with the client, he/she will chew up about 63 hours or 40% of a 160 hour month. Given the additional responsibilities associated with tactically managing portfolios in real time, the business model and our sanity are coming under increasing pressure.
That begs the question: what is going to give … client communication, investment management or “my life”? In August, many emerging advisors learned the hard way that it was “their life” that suffered as turbulent markets interrupted long anticipated and well deserved vacations. With that interruption so fresh in our minds, we thought this an opportune time to explore an alternative world where neither the client nor the advisor is forced to choose between those three options.
Consider how this story might have unfolded if our example advisor outsourced investment management to a manager that employs tactical asset allocation. We can use the internal structure of Pinnacle Advisory Group as a proxy. Pinnacle created a centralized money management capability that employs tactical asset allocation about the turn of the millennium. Wealth management teams now focus only on business development, financial planning and other client-facing activities. By outsourcing investment management, we freed 20-40% of their time to be more effective in those areas.
During the third quarter so far, and especially in August, our wealth management teams focused on proactively communicating with clients. They reviewed whether the most worried clients were in the correct investment strategy and talked them off the ledge. For others, they communicated the steps being taken by the investment team to manage risk in their portfolios. Advisors communicated with confidence knowing (a) that a dedicated team of five full time professionals were managing risk in real time while he/she was out working with clients and (b) that a team of full time professionals could produce a better investment result than a single advisor with multiple responsibilities working alone. Clients pick up on that confidence. They also feel more secure that the advisor can spend the necessary time with them because there is someone else minding their portfolios.
Meanwhile, the investment team worked overtime to support our advisors by (a) managing risk in client portfolios in real time and (b) supporting client communication.
- Risk Management. The buck stops with the investment team in terms of investment performance and risk management. The investment team is comprised of five full-time professionals that evaluate valuation, economic cycle and technical market data to develop an investment outlook and the appropriate investment strategy for each of its five risk models. The team makes adjustments to the risk models based on the “weight of the evidence” taking into consideration valuation, market cycle and technical analysis. Importantly, they can do so in real time because they have no other responsibility.
Over the last decade, markets have become faster and more volatile requiring an efficient process and an integrated team to monitor events and make decisions in real time. The third quarter highlighted this new reality as equity markets declined nearly 8%. But the bigger story was the volatility. There were as many up days as down days over the two month period and daily price changes were extraordinary. In August for example, the average down day amounted to (2.7%) and the average up day amounted to +1.7%. Risk management is paramount in such an environment.
The investment team worked full tilt during the third quarter and especially in August. They held 3-4 formal team meetings per week plus countless sidebar conversations around the trading desk trying to responsibly absorb and evaluate a dizzying number of political, economic, financial and market variables in flux.
The team’s conclusion based on the “weight of the evidence” was that market volatility reflected an expectation of higher risk in the economy and the markets that required adjustments to the model portfolios. Accordingly, the team reduced risk. For example, the team reduced the equity allocation in the Dynamic Moderate Growth portfolio model on four separate occasions during August from a neutral 60/40 at July 31st to 51/49 by August 31st. The team also adjusted 6 of 8 sector allocations to reduce risk within the equity allocation. As a consequence of prior positioning and their August actions, every risk model outperformed its benchmark during August by anywhere from 15-40 bps.
- Communications. The investment team must also arm its advisors so they can effectively communicate with clients. During the month of August, the investment team hosted two investment committee meetings to brief advisors on the changing market outlook and the associated portfolio adjustments, published two special reports that advisors could send to clients and posted 16 articles to its investment blog “Echoes From The Pit” for those clients looking for information closer to real time. At month-end they will publish its regular investment outlook and portfolio review for clients.