Consider this example: In January 2000, a 50-year-old client had $2 million, and his retirement was looking reasonably secure. But by 2002, if he was lucky, he'd only lost half his nest egg. By the fall of 2006, again if he's lucky and had a good advisor, he'd climbed back to $1.7 million or so. Then, by April 2009, he'd lost another half and was down to about $850,000. Today, his portfolio is back to nearly $1.3 million, but his prospects for an early retirement have vanished—and his future isn't looking nearly as bright.
These days, every financial advisor is familiar with this scenario, regardless of their personal experience: As clients approach retirement age, their time frame for riding out major market corrections shrinks, exposing the flaw in traditional asset allocation. In fact, the entire advisory profession is wrestling with the problem of what to do about it. While there are a number of strategies that purport to offer a solution, until recently, none have convincingly overcome the likelihood of actually increasing risk rather than reducing it, or the potential for adding substantially higher costs.
Sure, you can limit risk by reducing exposure to equities, but in the current ultra-low interest rate environment, portfolio growth will slow to a crawl, requiring the downward revision of many retirement plans. What's more, with massive global debt levels nearly a lock to drive interest rates up, bond holdings don't look nearly as low-risk as they used to (it was recently pointed out to me that when interest rates go up 1%, long-term bond values fall in the neighborhood of 19%). That leaves moving aging clients into all cash, which, after any inflation, means dwindling portfolios; that doesn't bode well for rosy retirement plans either.
Another option, of course, is to try to "time" market downturns through strategic or dynamic asset allocation, a direction in which many advisors are turning, or at least exploring. The problem with this solution is that myriad studies and loads of anecdotal evidence suggest that even if such timing is possible, success on a regular basis requires such a specialized talent that its use for managing retirement portfolios on an industry-wide basis seems irresponsible.
That leaves us with hedging strategies: using sophisticated financial instruments to limit the downside exposure of equity or debt holdings. We know that large institutional investors have used hedging strategies to manage their portfolio risk for years, often quite successfully. Yet, the relatively high cost of both the hedging vehicles themselves and the expertise to use them effectively has prohibited their use in all but the largest retail portfolios. At least, that's been the case until recently, when the explosion in the size of the retail retirement market combined with its huge demand for better risk management, has motivated the financial industry to make hedging tools more affordable.
I recently discovered just how far this trend has progressed when I was introduced to Harry Clark, founder and CEO of Clark Capital Management Group in Philadelphia. A 40-year veteran of the financial services industry, Clark founded CCMG 25 years ago to manage retail portfolios. It wasn't until the mid-1990s that he began to feel uncomfortable with increasing market volatility and started to look for better ways to manage portfolio risk. It was during this time that he realized volatility itself could be thought of as an "asset class" and therefore managed within an allocated portfolio. But the cost of hedging strategies was a major limitation.
CCMG's big break came when Clark's theory was put to the test in 2001. "The dot-com crash was a big turning point for us," he remembers. "Both because even back then, our portfolios did better than most; and because in the aftermath, a growing number of more sophisticated risk management products were introduced into the retail marketplace." During the recovery of the following decade, the firm became a TAMP and focused its business on managing assets for clients of independent advisors and on other TAMP platforms, increasing its assets under management from $500 million to $3 billion today.
