Self Improvement

Only 23% of the advisors surveyed somewhat or strongly agreed that interest rates will increase dramatically. Advisors may find it beneficial to communicate their reasoning behind their views on this topic with their clients, as evidently many clients have a decidedly different take on a fundamental threshold issue affecting their portfolios.

Use of traditional asset allocation strategies. The majority of RIAs surveyed (63%) said that allocating among the three main asset classes–equities, fixed income, and cash–can provide adequate diversification for their clients. Nevertheless, our investor survey showed that only one in four (23%) has a formal asset allocation strategy in place. The remaining respondents (57%) use an informal strategy or no asset allocation strategy at all. This suggests a wide chasm between advisors and investors on why asset allocation strategies are important.

More Tactical, More Opportunistic Approaches

While all advisors use a wide array of investment strategies to manage day-to-day portfolios, most of those surveyed expressed interest in using more targeted strategies to eke out incremental returns or manage various risk exposures in future sideways or down markets.

Ranking strategies if interest rates rise. Of the 23% of advisors mentioned earlier who strongly or somewhat agree that interest rates will increase dramatically, they all have different approaches to protect their fixed-income investments. Forty-five percent would sell fixed-income holdings that are most sensitive to interest rate movements, such as interest-rate sensitive stocks, 20- or 30-year bonds, or certain mortgage-based fixed income holdings. Twenty-five percent would sell all fixed-income holdings, 16% would shorten average maturity of fixed-income holdings, and just 8% would utilize an inverse bond mutual fund product.

Keeping up with down markets. In a market downturn, most advisors tend to make changes to their portfolios to minimize losses and risk. Almost half of advisors (46%) try to do this by purchasing non-correlated assets. Thirty-two percent of the financial professionals surveyed continued to invest (or dollar cost average), 25% of advisors use shorting strategies (other than stocks), 10% use leveraged and inverse investments, 7% short individual stocks, and 8% purchase index put options.

Only 11% of the investors surveyed indicated they would use inverse funds, leveraged funds and hedging strategies to seek to benefit from market downturns. If advisors are to make effective use of these techniques in managing client assets, additional educational work likely will need to be done to raise clients' comfort levels.

Using economic factors as part of client planning. During the investment planning process for clients, almost all of the advisors (99%) factor in current interest rates, oil prices, and real estate values. According to the majority of advisors surveyed (85%), the present energy crisis has not significantly affected their clients' approach to investing.

A majority of advisors (63%) reportedly meet with clients to readjust their portfolios based on market conditions, rather than on a calendar basis (25% reported quarterly meetings; 13% monthly client meetings). Making more frequent adjustments to an asset allocation strategy than traditional asset allocation approaches is generally perceived as a superior way to optimize the risk-reward characteristics of client portfolios. Nevertheless, trading costs and tax ramifications must be considered when following a more frequent rebalancing approach.

Final Thoughts

To get to the next level, many advisors recognize that simply maintaining the status quo is not enough. They're continuously examining their business plans and investment processes to look for improvements. They're clearly becoming more opportunistic in their investments. On the other hand, average investors may not yet understand how these approaches may prove to be beneficial in growing and protecting wealth in different market environments.

Advisors plainly need to close the knowledge gap with clients–through better education and more aligned expectations–if they are to increase their level of client retention and new referrals. Surprising differences have emerged between advisor and client perceptions of the investment climate, as well as the deployment of available alternative strategies and techniques that can be used to manage risk in up and down markets. Ultimately, we believe the biggest area for advisor focus in 2006 may well be in client education and client service.

Maya Ivanova is a research analyst with Rydex AdvisorBenchmarking, and can be reached at [email protected].