The volatility earlier this year that impacted the equities market is driving registered investment advisors to take a hard look at their client portfolios and to explore alternative sources of return as well as ways to reduce costs.
“We just haven’t had this kind of volatility that we’ve seen over the last eight or nine months since the second half of 2011,” says Todd Petzel, CIO at New York-based Offit Capital, an RIA firm that manages $9.5 billion. “People got a little bit out of practice as to what volatility can really do.”
In fact, what volatility did was to fuel 18 straight quarters of outflows from U.S. equity strategies though the end of 2015, with investors pulling $990 billion out of U.S. equity strategies since 2011, according to eVestment data.
As a result, along with investment banks, many RIAs have turned bearish on equities and don’t anticipate an imminent reversal.
“Future price gains in stocks [are] going to be somewhat limited,” says Deron McCoy, CIO at Signature Estate & Investment Advisors, a Los Angeles-based $5.14 billion RIA firm. “What we are doing…is scaling back some of our equity exposure. If we think we are going to get mid- to high-single digits out of stocks with a lot of volatility, we are looking for other areas around the world and other asset classes that can get us the same type of return with a lot less volatility.”
Places where RIAs are looking for better returns for their clients include high yield, municipals, emerging markets debt, commodities and managed futures. In addition, some advisors are giving consideration to the burgeoning smart beta segment.
Although the RIA channel is notably heterogeneous, asset managers that cater to RIAs are detecting some trends among those advisors.
“The S&P 500 was the largest net outflow among RIAs in the first quarter,” says Hollie Fagan, head of the registered investment advisor and retail investor platforms at BlackRock. “You could surmise that the source of adding to the high yield market, adding to alternatives and commodities, was sourced from that S&P 500 equity exposure.”
Legg Mason for its part has also seen the move away from US equities benefit some areas of the fixed income market.
“[RIAs] are opportunistically seeing value in credit,” says Sean Mackley, head of wealth management and consultant/client service at the firm, adding that high yield and investment grade bond strategies have gained interest among RIAs. “As volatility comes in, you see more and more interest in core bonds that are outside of the U.S.”
SEIA’s client portfolios are being conservatively repositioned. “We are taking some of the equity money off the table and reallocating it to credit fixed income and private real estate,” McCoy says. Within those asset classes, the firm’s preference is for credit bonds tied to non-agency mortgages and to commercial real estate mortgages, he adds.
The volatility and the scarcity of alpha is also driving many RIAs to trim costs, selecting just a handful of active managers and using passive investments for the remainder of the portfolio, asset management executives say.
“RIAs… are willing to pay for alpha to a manager that is able to deliver something that the advisor themselves can’t replicate, but they are very fee conscious” Fagan says. “They are unwilling to pay alpha fees for beta returns.”
Coral Gables, Fla.-based Miguel Sosa, a solo practitioner who used to manage $400 million at Merrill Lynch and now is building his independent practice, has client portfolios “heavily weighted towards index funds.” In addition to index funds at the core, Sosa is adding master limited partnerships and factor-based strategies “that will provide enhanced returns,” he says. “Within the traditional portfolio we are looking to enhance returns by being more dynamic and increasing our value exposures.”
Similarly, SEIA has moderately incorporated MLPs into its clients’ portfolios. “The selloff [in MLPs] was tied to oil,” McCoy says. “You wouldn’t want this to be a sizable portion of your portfolio due to the volatility but…a little bit of MLPs that kick off mid- to high-single-digit-type returns is attractive to us.”
MLPs have also caught the eye of Offit Capital’s Petzel, who is adding the asset classes to the portfolios of clients who are “positively inclined to the market.” Although MLPs have rebounded, he says, “they are still relatively cheap to where they’ve been over the last three years or so.”
Yet, some say that if portfolios are set up properly before volatility hits, there is no need for change.
“We haven’t made any major changes to the portfolios this year tied to the market volatility,” says Bill Glasser, executive vice president of portfolio management at $60 billion RIA Fisher Investments. “We are probably in the later stages of the bull market. In that type of environment, the characteristics investors tend to seek out are big, global, mega-cap companies with stable earnings, stable sales growth, big fat gross operating profit margins, strong balance sheets [and] stable cash flows.”