Active asset allocation may cost you in more ways than one

Active asset allocation may cost you in more ways than one
Firms that use a third party that actively allocates investments to the point of market timing can see tremendous attrition when their returns are negative and not aligned with the market.
OCT 25, 2023

My first experience with fee-based asset management was in the 1990s with an investment program that practiced “active asset allocation.” I sold it to nearly all my clients and it was a disaster.

The investment program had some cool sales tools that would analyze the performance of different mutual funds over a variety of periods. The goal was twofold: first, to own only top-performing mutual fund managers, and second, to allocate between stocks and bonds to protect assets while providing growth.

The problem was the investment manager was not at all proficient at determining which mutual funds would be the top performers in the subsequent quarters and years. Nor were they capable of determining which asset classes to overweight and which to underweight.

The returns were down while the stock market was soaring, so of course my clients weren’t happy. The investment manager believed, based upon some model, that stocks were overvalued and what my clients were feeling was “contrarian heat.” The clients simply needed to be patient until the thesis was proven out.

Fortunately, I didn’t stick with the program very long and decided that my clients, as well as myself, would all be much better off with a portfolio dominated by index funds without the market timing that was disguised as asset allocation. I lost a few clients during this period but was fortunate that many still stuck with me as I transitioned from an asset manager to a more basic investment approach.

This experience taught me two valuable lessons: One, selling my clients on the value of a specific investment manager would sting badly when (not if) the performance was off. And two, because it’s hard to sit on the sidelines when all your neighbors are making money, clients won’t tolerate “contrarian heat” for long.  

Here’s what I’ve witnessed in more recent years. Those firms that use a third party that actively allocates investments to the point of market timing have tremendous attrition when their returns are negative and not aligned with the market. Sure, folks may stick around a year or two, but unless their performance catches up to where it should be, these types of clients will find another advisor.

This is all highly problematic for any advisor who's planning on selling their firm. That’s because when a firm has touted to its clients the prowess of a specific investment strategy, whether deployed by the advisor himself or by a third party, and that strategy underperforms, the value of the firm will decline precipitously.

Remember, a 10% drop in client assets from attrition (or poor investment performance) doesn’t translate into a 10% drop in a firm’s value. The drop could be 20%, or more, given that the fixed costs of a firm remain the same, while the revenue is declining. Further, a firm that is slowly shrinking has a much smaller net present value than a firm that is experiencing some growth.

If your goal is to sell, merge or transfer your business in the next few years, having your portfolios managed in a more mainstream way will ensure both that you have high client retention and that you will receive maximum value when you transact.

Scott Hanson is co-founder of Allworth Financial, formerly Hanson McClain Advisors, a fee-based RIA with approximately $16 billion in AUM.

More workers delaying retirement, needing financial advice, says F&G CEO

Latest News

SEC Says Game Service Roblox Part of ‘Active Investigation’
SEC Says Game Service Roblox Part of ‘Active Investigation’

Short sellers previously said the company was under investigation, though Roblox denied allegations.

Musk’s DOGE descends on CFPB with intention to shut it down
Musk’s DOGE descends on CFPB with intention to shut it down

The Consumer Financial Protection Bureau is in the crosshairs of the Republican group that is widely attempting to dismantle government agencies.

Advisor fighting Finra banishment loses $17.7 million dispute with old firm
Advisor fighting Finra banishment loses $17.7 million dispute with old firm

National Securities Corp. sued the advisor in 2020, alleging breach of contract and unjust enrichment.

Job numbers, inflation leaving room for Fed to hold rates
Job numbers, inflation leaving room for Fed to hold rates

Recent data support a measured pace by the Federal Reserve for the year ahead.

Private assets remain hot despite surging stock market
Private assets remain hot despite surging stock market

Financial advisors are still adding alternatives despite the surge in publicly traded stock prices

SPONSORED Taylor Matthews on what's behind Farther's rapid growth

From 'no clients' to reshaping wealth management, Farther blends tech and trust to deliver family-office experience at scale.

SPONSORED Why wealth advisors should care about the future of federal tax policy

Blue Vault features expert strategies to harness for maximum client advantage.