Time for a new strategy

Updated: May 31 2009, 05:56am hrs
If the last 18 months have taught Americans anything, it's that market collapses don't discriminate. Even the most sophisticated and affluent investors lost big chunks of their fortunes. Access to the most exclusive hedge funds did not always limit the damage, as many participants had hoped it would. As a result, a new mentality has emerged among some investors, who are rethinking the traditional approach to asset allocation. The upheaval in the markets and in the broader economy has led them to question long-honored principles of investing and to sound a death knell, at least for now, for the buy-and-hold mind-set.

Moving away from the conventional mix of stocks, bonds and cash, many affluent investors and their advisers are turning to alternative investments - like managed futures and hedged mutual funds - that are liquid but behave differently from the rest of the investment pack.

And some of the wealthiest investors are beginning to shed the bunker mentality, at least long enough to exploit shorter-term opportunities. In an environment of extraordinary uncertainty, the traditional role of asset allocation and long-term investing is far more difficult," said Michael Sonnenfeldt, chief executive of Tiger 21, a forum for wealthy investors who meet monthly to discuss financial matters. Many of our members believe we are in a trader's market where long-term investing should be shunned but trading opportunities should be seized." Indeed, many investors are reluctant to place longer term bets and cling to larger cash allocations, anticipating continued volatility.

The landscape going forward is extremely uncertain," said Hans Olsen, chief investment officer at JP Morgan's private wealth management unit. There are many possible outcomes. You need to have a portfolio structured to reflect many possible futures. It comes down to the first principles of diversification." But how you define diversification is evolving.

In a bull market, we don't tend to care that our portfolio investments seem to behave the same, but I believe this bear market has uncovered a long-term problem," said Jerry Verseput, a financial planner in El Dorado Hills, Calif., noting that technology and globalization have diluted the effectiveness of diversification based on company size and location. So he has embraced a new approach, using a portfolio of exchange-traded funds, or ETF's, that track different sectors of the economy, like energy and health care. Below, several investment professionals describe how their philosophies have changed and how they are reallocating their portfolios. And one stalwart traditionalist explains why he thinks all of this is a lousy idea.

Balancing with alternatives

George Padula, a senior wealth manager at Back Bay Financial Group in Boston, predicted that market volatility would not abate anytime soon. Indeed, with BlackBerries ubiquitous and news traveling so fast, markets react more quickly than ever, he said. So Padula and his colleagues came up with a way to balance their clients' short-term worries with a longer-term strategy. For most clients - whose net worth runs from $2 million to $4 million - they have increased cash positions and their allocations to alternative investment funds, including managed futures, which actively trade commodity, currency and financial futures contracts. He invests in commodities through a diversified fund that can take long and short positions and in hedged-equity mutual funds that try to use option strategies to cushion market hits. This approach, obviously, includes a pullback on stocks. Padula's most aggressive portfolio now dedicates only 65% to stock index funds, down from 80 to 90%. Alternative investments account for 23% of that portfolio, fixed income for 8 percent and cash for 4%. The firm also created more conservative strategies for clients who no longer want sleep aids to get through the night. One such model shifts money from stock funds (down to 22%) into alternative investments (33%), fixed-income (29%) and cash (16%).

The shifts have been well-received by clients, he said, adding, They recognize that circumstances are very different now than they have ever been, and proactive steps are needed to counteract the increased market risks and their reduced capacity for risk."

Passive no more

Cathy Pareto, a fee-only adviser in Coral Gables, Fla, came from the passive school of investing, where you invest your portfolio in a diversified basket of index funds. But in today's world, she says, you can be too passive. Buy-and-hold was the mantra, but in light of recent events and a dramatically different world, those tenets may not always apply," Pareto said.

She now dedicates 5 to 10% of her clients' portfolios to more tactical moves. Currently, those include sector ETF's, like consumer staples, global materials and technology, as well as an ETF that bets against real estate investment trusts. That has been a radical change for me," she said. One thing she likes about ETF's is their trading flexibility. Unlike mutual funds, ETF's can be traded just like stocks.

A passion for cash

Paul Speargas, a senior client adviser at WMS Partners, a family office and wealth advisory firm in Towson, Md, is looking in some unlikely spots for investments - notably those that do not move in line with the market. His firm has purchased streams of cash - or discounted cash flows - from people who have been awarded large sums of money, like lottery winnings or court settlements, but receive them as annuities.

It's a real niche," said Speargas, whose clients' net worth ranges from $10 million to $12 million. What we are doing is going through third parties to buy annuity contracts that people have been awarded." That strategy is part of a low-risk core portfolio. But along the edges, the firm has been looking for short-term trading opportunities in a more predictable place: the stock market. Since mid-October, it has been actively trading shares of high-quality, large-capitalisation companies with rock-solid balances sheets, he said. The proverbial babies thrown out with the bathwater," he adds, which include Google, Verizon and Nucor Steel.

The buy-and-hold strategy, which was almost universally accepted by the investment and academic community over the past several decades, is no longer the sole investment strategy to be employed in order to deliver solid investment returns," Speargas said. A thoughtful balance between long-term investing and short-to-intermediate term trades is likely the recipe for investment success in the volatile years ahead."

Tara Siegel Bernard / NY Times