Portfolio re-balancing becomes high-wire act

Advisers forced to rethink tried-and-true strategies to soothe shellshocked clients

Dec 7, 2008 @ 12:01 am

By Jeff Benjamin

With the stock market down more than 40% from the start of the year, the idea of portfolio re-balancing has taken on new meaning for many financial advisers and their clients.

While some advisers insist on sticking with the asset allocation model that seemed to make sense before the financial markets started imploding, others are finding the conditions too much for their clients to bear. Some might even be revisiting client risk-tolerance levels.

"The right thing to do is to re-balance the portfolio, but that can be a tough thing to do for some clients," said Clay Ernst, a portfolio manager at Bingham Osborn & Scarborough LLC in Palo Alto, Calif.

"As the market has gone down, we've found that clients are starting to guide us in a different direction," added Mr. Ernst, whose firm manages $1.7 billion in client assets.

The stock market's decline has effectively re-positioned most portfolios into a more conservative allocation, with a larger weightings in fixed income and cash in relation to stocks.

"Clients realize their portfolios have migrated to a more conservative allocation and most of them are falling into the camp of 'no action,'" Mr. Ernst said. "My guess is you won't see that many people who are really driven to re-balance, but we're just trying to prevent people from really hurting themselves by going all in to fixed income and cash."

The initial assumption that the financial planning community would stick to the long-term asset allocation models and automatically bring hundreds of thousands of individual client portfolios back into balance seemed like a potential boon for the equity markets, according to Duncan Richardson, chief equity investment officer at Boston-based Eaton Vance Corp., which manages $123 billion.

"The re-balancing is potentially quite material," he said. "The one-year decline in equities is greater than any time since 1931, and this eventual re-allocation could be the 2009 silver lining for the cumulonimbus cloud of equity underperformance we have experienced in '08."

The wrench in the works of Mr. Richardson's theory, however, might be that many advisers and clients have altered their views in stride with market conditions.

"Right now, we're spending a lot of time reminding clients that they are still on target to meet their investment goals," said Lon Jefferies, a financial adviser with Net Worth Advisory Group in Midvale, Utah.

"If a client feels like they could stomach a market period like the 1930s or the 1970s, then we're buying equities at yearend," he added. "We're way out of historical norms right now, but we anticipate that those things hit hardest will be the first to rebound."

Mr. Jefferies, whose firm oversees $75 million for a client base that averages 60 years of age, is in the company of a lot of advisers who are living the new reality of year-end portfolio re-balancing in the midst of a global financial crisis.

While advisers might normally re-balance once or twice a year, or whenever the allocation gets a certain percentage out of balance, the sudden and severe downturn across the equity markets has introduced a whole host of strategies and theories from the advice industry.

One argument against re-balancing is that fixed income has more upside potential in the current market, according to John Hutchins, president of Comprehensive Planning Associates Inc. in Lebanon, N.H.

"I think the risk-return ratio has changed and right now, potential bond returns per unit of risk is greater than with equities," he said.

Mr. Hutchins, who oversees $30 million in client assets, pointed out that prices of domestic and international corporate bonds have been driven down due to the liquidity crunch.

"If you solve the liquidity crisis, then bonds come back to normal," he said. "Right now it looks imprudent to be selling into this bond market, because I could see the bond market coming back without the equity market coming back."

Meanwhile, it is difficult for some advisers to ignore the deep discounts spread throughout the equity markets right now.

"We think this is an opportunity to get more aggressive," said Kevin Reardon, president of Shakespeare Wealth Management Inc. in Brookfield, Wis.

Mr. Reardon, who oversees $50 million in client assets, has held most client portfolios at a 60% stock and 40% bond mix since July 2007.


His current strategy is to increase the weighting in stocks to 80%.

"Our model is very simplistic, we want to be cautious when everything is great, but when everyone is negative we want to move forward in a more forceful way," Mr. Reardon said. "We throw out the analysts' coverage and we ignore all the media and we just look at the valuations."

Some advisers are finding it surprisingly easy simply to stay the course with an annual client review that moves the portfolio back to the target allocation.

"Everybody is underweight equities right now, so most of my clients are buying," said Gregory Fenton, owner of Cambridge Cape Cod Advisors in Sandwich, Mass.

Mr. Fenton, who advises clients on a flat-fee or retainer basis, said he expected more resistance from clients when it came to recommending they buy more stocks.

"This is when the strategy proves itself, but I was shocked by the way my clients responded," he said. "I thought they would be nervous, but most of them said 'no problem, that's what I thought you'd say.'"

E-mail Jeff Benjamin at jbenjamin@investmentnews.com.


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