Advisors Speak Out

By MARION ASNES

Asset allocation is a first principle of financial planning, as essential to the practice as thinking was to Descartes. And yet, as practices become more sophisticated, this indispensable tool of portfolio management has become more difficult to wield consistently. Clients may resist the idea of rebalancing, convinced that their winners need to run. Practitioners feel pressure to spend less time tinkering with portfolios, and more time prospecting for new clients (as well as meeting with clients already on the roster). You may be contemplating putting your clients into asset allocation funds--but then, you wonder, why does the client need you?

How do we know this? We asked. This summer, Financial Planning, along with AllianceBernstein Investment Research and Management and Mathew Greenwald & Associates, a research firm, surveyed 567 financial advisers nationwide about how they employ asset allocation in their practices. What we learned surprised us--and revealed that an unexpected number of advisers still need help. For instance, although 94% of you agree that asset allocation is at least as important as individual investment selection (an assertion proved in 1986 in a study by Gary Brinson and others), only 63% of you offer an asset allocation plan to every client--and 30% of you lack a formal approach. What's more, a plurality of you, when asked how you would grade your peers' ability to get clients to stick to a proper asset allocation plan, gave them a mere gentleman's C.

All of the advisers in our survey had practiced for at least five years and had at least $25 million under management, so there's no excuse. But there are reasons. And that's what our survey explores. (The complete results are available here.)

THE STUMBLING BLOCK

The sticking point for portfolio management, you say, isn't diversification. Almost all of you spread your equity positions around the style boxes, buying growth, value and international stocks. Three-quarters of you have your clients in REITs and two-thirds have emerging-markets exposure. Many of you even move well beyond the standards--you've got natural resources, commodities and high-yield debt in the mix. One-quarter of you have some clients in alternative investments, including hedge funds.

The trouble comes when you have to re-balance portfolios. You believe that a properly maintained asset allocation plan would have added 68%, on average, to a typical investor's portfolio over the last 30 years (that's 164 basis points per year). But your clients resist your best efforts.

A perennial stumbling block for your clients is neglecting to take profits. Everyone loves a winner and investors are no exception. Who wants to sell a great performer and redirect the cash toward a sector that's in the tank? Indeed, 81% of you report that your clients are reluctant to rebalance for this reason.

In addition, your clients know taxes and transaction costs create friction that can brake the smooth growth of any portfolio. Clearly, a good portion of you aren't adequately communicating your ability to minimize, or at least manage, the burn.

REGULATED REBALANCING

The good news is, you realize that your most important job--and one that 52% of you want to devote more time to--is communicating with your clients. The aversion they quite reasonably feel toward rebalancing portfolios (which, as you know, is a completely counterintuitive activity) can be managed.

One way to do that is by creating asset allocation models and a rigorous rebalancing program that takes effect at specific time intervals. Forty-three percent of you already do that, typically at least once a year. Another popular technique is to rebalance when the market moves enough to shift your allocations beyond a set parameter. This technique is embraced by 50% of planners, who swing into action when an allocation moves, on average, 15% beyond its model.

A third path is to turn over the portfolio to asset managers who do the heavy lifting by allocating assets and rebalancing them as part of a predetermined program. This is the raison d'etre for the growth in asset allocation funds, turnkey asset-management programs and separately managed accounts. AllianceBernstein itself has followed this route with private clients for decades, in Bernstein Investment Research and Management before its merger with Alliance Capital.

Bernstein's 235 private advisers, who each have, on average, $300 million under management, do not invest any money themselves. They spend their time bringing in an average of $50 million in new business a year. "Bernstein financial advisers do not pick anything," explains AllianceBernstein chairman Marc O. Mayer. "Everything they bring to a client, we manufacture. The financial adviser's job is cultivating the clients, then communicating with and servicing them."

Okay, so you're not with Bernstein. But you do have access to vehicles that perform similar tasks. A slew of manufacturers have introduced asset allocation products based on either a client's risk profile or target retirement date. Retirement-plan sponsors love them, and 62% of you use them as core holdings already.

Now, AllianceBernstein is introducing asset allocation products for normal-net-worth clients that are based on the Bernstein approach. With a new campaign, called "The Right Mix," the company is rolling out retail versions of its asset management combo platters geared toward wealth building, retirement and education planning. These new products, available only through financial advisers, went on the market in October. A new Web site, www.TheRightMix.com, will introduce both advisers and clients to the products.

UNRAVELING THE PARADOX OF CHOICE

One advantage to using an all-in-one asset allocation product is that you no longer have to spend time selecting funds that fit your model, an activity that 30% of you would like to do less. As products proliferate, choices become harder, even paralyzing--although the net improvement to the portfolio may be only marginal.

Common sense says that, with investment products, the more choices, the better; but in fact the reverse is true. In a new study of investor behavior, psychologist Sheena Iyengar, PhD, an associate professor of management at Columbia University Business School, found that individuals became overwhelmed by choices and retreated into passivity.

Iyengar reviewed the participation of nearly 800,000 investors in 401(k) plans based on data supplied by Vanguard and compared participation rates to the number of choices. Employees whose plans offered only five options had a predicted participation probability of 72%. But when the number of choices jumped to 35, the likelihood of participation dropped to 67.5%--even when the participants were offered an employer match. "Overall, for every 10-option increase," Iyengar writes, "the predicted participation probability declines by about 2%." As the number of options grew, participants also became more risk-averse: "For every 10 funds added to a plan, there is a 5.4 percentage point increase in allocation to money markets and bond funds," Iyengar says.

Are professional planners subject to the same effects? Iyengar's research does not answer that question specifically. But her results have been confirmed in studies of choices in jams, chocolates and other consumer goods, where choices abound and expertise is not an issue.

Your clients may feel the same way about your complex, brilliantly constructed portfolios. Too many elements can be a distraction. AllianceBernstein has tried to sidestep choice confusion by offering products based on goals (such as Wealth Strategies, Retirement Strategies and Education Strategies) rather than on investment vehicles. The idea is to encourage recalcitrant clients to buy in. "That's what drives us to work on this," Mayer observes. "The stakes are high, and the results are in the future. But the defined-contribution generation is going to retire soon and our choices will matter."

REFRAMING PORTFOLIOS

The trouble with this black-box approach, though, is that the advisers themselves still need to be able to see in. And when clients ask questions, advisers need to be able to explain, convincingly, ideas about asset allocation that are not sexy, not hot, not new--but still astoundingly valid.

According to Ranji H. Nagaswami, AllianceBernstein's vice chairman and chief investment officer of the fund investors group, advisers have to learn to reframe the portfolio conversation. "We need to stop talking about winners and losers," she says. "Diversification among noncorrelated assets means, by definition, that something will lag." Investors are too ready to kick laggards out of their portfolio, she says, and overconcentrate in their outperformers--as you may know all too well. "My 'Aha' from the survey was advisers' frustration," Nagaswami observes. "If only they could get clients to stick to their allocations they'd do so much better."

Nagaswami is taking an innovative approach to The Right Mix portfolios, one that, she avers, points the way to the future of investing. Rather than creating a strict balance of domestic versus foreign equities, she is building a global portfolio. "Today, among developed economies, countries don't matter so much," she says, observing that less than 20% of a large-cap stock's return is related to market equity in its own country. "Systematic economic risk is now highly correlated. The company and industry--the idiosyncratic risk--is more important overall."

Instead, Nagaswami diversifies among asset classes and investment styles. Portfolios are divided among global growth, global value, REITs and fixed income. They are rebalanced based on an algorithm: When equities move 5%, or bonds move 3%, out of line, the assets are shifted back. This enables the portfolios to capture profits from market spikes and average down when values sink.

But her case remains unproven. The Right Mix is too new to have a track record, and there's plenty of competition. Turnkey asset management programs and separately managed accounts offer similar conveniences, are gaining popularity and are more flexible than asset allocation funds. Many advisers don't like the asset allocation funds already on the market, which tend to have mediocre returns and high fees.

Here's what you have to say about asset allocation funds, both pro and con: 67% of you say the funds help you keep clients because you've put money management decisions in the hands of specialists. But 72% of you say you don't really need an asset allocation fund because you have your own diversification approach, and 65% of you don't believe that any one fund manager can provide quality offerings across multiple styles. What's more, 44% of you believe that asset allocation funds don't provide good value because of high fees, and 39% think the funds don't make sense for clients with more than $50,000 to invest. Moreover, 43% of you question how you would explain your value to clients if you switched to asset allocation funds.

A NEW SALES CAMPAIGN

In a sense, The Right Mix is the product that lays claim to both Bernstein's investment expertise and Alliance Capital's sales know-how. It's a true child of the two parent firms. While Bernstein managers bring in multimillion dollar accounts, Alliance reps work with more modest portfolios; the average account is $10,900. It is these clients--and the advisers who turn to AllianceBernstein as a distributor--who will be the targets.

These smaller-scale advisers are the focus of a huge education and advocacy program spearheaded by Ray Sclafani, managing director of AllianceBernstein's training arm, The Advisor Institute. Sclafani sees The Right Mix program as a means for these advisers to revolutionize their practices. Stock- and fund-pickers, he says, are still suffering from clients' disappointment in the wake of the bear market. "Advisers have been on the defensive for four, five years," he says. "This is the time to be proactive."

Sclafani says advisers need to talk to clients in a manner he calls "benchmarking the beach house." Instead of focusing on the performance of portfolio elements relative to their benchmarks, he says, advisers would do best to compare the overall portfolio's growth with the client's real-life goals. With investments, it seems, it's the destination, not the journey.

As this poll reveals, running the money is not enough, and will never be enough. Whether asset allocation products represent the best answer to your practice issues remains to be seen, and the category still needs to prove its value. But they're one way to freeing up adviser's time to spend with your clients.