Advisors: Plenty Of Risk In An Otherwise Sunny Market

Natixis is out with its latest investment advisor survey and there’s much on the menu for wealth managers to mull over.

The survey queries 300 advisors, RIAs, and independent broker-dealers on key issues such as financial market challenges and managing client portfolios in a risk-laden market environment.

Here are four immediate, but eye-opening, takeaways from the survey:

• The extended bull market has led to complacency among investors, as 64 percent of advisors do not believe investors are prepared for a market downturn.
• Current market environment favors active management, according to 83 percent, who continue to allocate the bulk of their assets to active strategies.
• Financial professionals believe rising rates will have a negative effect on investment performance, increase market volatility and portfolio risk.
• Nearly half of respondents say clients reacted emotionally to recent volatility, a dangerous omen if markets experience a severe decline.

The Impact Of Interest Rates

What do advisors have to say about the survey results, and the accompanying “snapshot” of their profession? Here are five long-range views from industry insiders:

Better rates for client savers. An important aspect for investors is that while rising rates hurts bond prices in the short term, the outlook for savers is a better one as a result of increased rates.

“Savers notice it first in their savings accounts, money market funds and then short-term bond funds via increased interest they receive on those accounts,” said Adam Jordan, a wealth manager with Paul Ried Financial Group in Bellevue, Wash. “But even intermediate to long-term bond investors will be better off over an extended timeframe.”

Despite long-term bonds taking an initial hit in price, they will ultimately benefit more than if rates stayed lower, as their interest payments and maturing principal gets reinvested at higher and higher rates, Jordan said.

“The bigger threat to investors due to rising rates is stocks. With such extended valuations on U.S. stocks, increased rates on safer assets may draw investors away from stocks,” he said.

Potential for client miscommunication. Clients reacting negatively to recent volatility can be tied back to advisors’ poor communications, said Scott Eichler, an investment advisor with Newport Wealth Advisors in Newport Beach, Calif.

“Our industry uses words to define risk appetite,” he noted. “We say ‘aggressive,’ ‘moderate,’ and ‘conservative,’ and clients use the exact same words.”

Through years of working with families, Eichler learned that client definitions of these words don’t always match up with reality.

“Most investors that come through my door believe they are moderate when nothing could be further from the truth,” he noted.

Volatility begets volatility. During times of increased volatility, clients tend to overlook their deemed investment time horizon, which leads to irrational behavior and capitulation during market corrections.

“As disciplined investors, we encourage our clients to maintain a long-term focus, as history has shown stocks have created the most value and wealth for clients,” said Tamer Elshourbagy, portfolio manager at Tompkins Financial Advisors. “With that said, investors should look for signs of euphoria in the market and maintain an appropriate balance of stocks and bonds in a well-diversified portfolio.”

Extended bull market leads to complacency. Complacency isn’t surprising because market participants mostly form their opinions about the future by taking current trends and extrapolating them on an ongoing basis, said Dieudonné Djimi, a fixed income manager at Natixis Asset Management in Paris.

“It’s a natural herding response which leads to consensus thinking and positioning,” he said. “Investors know that buying high and selling low is not the good strategy, yet my professional experience shows that they tend to buy after a period of strong performance, when valuation are higher and so the expected returns are lower.”

A balance between active and passive. Client portfolios should contain active and passive management, said Lou Cannataro, a partner at Cannataro Park Avenue Financial in New York City.

“Like the market itself, the active versus passive returns will vary,” Cannataro said. “Some years, active will win and some years passive.”

The big inflow towards passive investments is mainly due to an unusually robust market after 2008, sandwiched by the robust years leading up to 2008, Cannataro added.

“When the tide comes in, all boats rise,” he said. “The problem is many investors are pouring into passive models at possibly at the very worst time. When do we see the biggest increase in investments into the market? Typically, that’s just at the height when the stock market is about to correct.”

Brian O'Connell is a former Wall Street bond trader, and author of the best-selling books, The 401k Millionaire and CNBC's Guide to Creating Wealth. He's a regular contributor to major media business platforms. Brian may be contacted at [email protected].

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