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Fiduciary Insanity?

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Reflecting on the Lasting Impacts of the 2008 Financial Crisis

The finan­cial press has been awash with arti­cles com­mem­o­rat­ing the ten-year anniver­sary of the col­lapse of Lehman Broth­ers and the Glob­al Finan­cial Cri­sis (GFC). Many of these arti­cles have focused on the caus­es, what should have been done dif­fer­ent­ly, and the risks of anoth­er finan­cial cat­a­stro­phe.

The GFC was the biggest threat to the world’s eco­nom­ic sys­tem since the Great Depres­sion.  For­tunes were lost, lives were ruined, and the cur­rent pop­ulist upend­ing of the post-World War II order were all results of what tran­spired a decade ago.

The cri­sis has had a last­ing impact on investor atti­tudes toward risk. But even so, there are many indi­ca­tions the finance indus­try and investors are mak­ing the same mis­takes they made pri­or to the cri­sis.


Lasting Impact: More Conservative Investors

Despite the S&P 500 set­ting record highs, investor con­cerns have shift­ed to pre­serv­ing cap­i­tal rather than chas­ing returns. A recent study[1] by Cerul­li Asso­ciates, sum­ma­rized by ThinkAdvisor’s Emi­ly Zulz[2] and Finan­cial­Ad­vi­sor IQ’s Gar­rett Keyes[3], states that investors pre­fer down­side pro­tec­tion to out­per­for­mance by rough­ly a three-to-one mar­gin. While numer­ous finan­cial pro­fes­sion­als are focused on rel­a­tive per­for­mance ver­sus the S&P 500, investors would rather pro­tect what they have than shoot for the moon.

Demo­graph­i­cal­ly, those with the high­est empha­sis on cap­i­tal preser­va­tion are over the age of 60 or under the age of 30. This makes sense. Investors in the 60+ age brack­et would have been around 50 dur­ing the Glob­al Finan­cial Cri­sis. Many would have been in their peak earn­ing years and hope­ful­ly had a nice nest egg built up in 401(k), IRA, or 403(b) plans. With tra­di­tion­al asset allo­ca­tion mod­els los­ing more mon­ey dur­ing the GFC than the “worst case” sce­nar­ios pre­dict­ed, it is no won­der they are more risk-averse as their retire­ment draws near.

Mean­while, Mil­len­ni­al investors under the age of 30 would have come of age dur­ing the Glob­al Finan­cial Cri­sis. Many strug­gled to find work dur­ing the reces­sion and the prob­lem of stu­dent debt has been well doc­u­ment­ed. Roll in dis­trust of the finan­cial sys­tem, and you have a recipe for con­ser­v­a­tive investors.

Despite these shifts, many of these investors are tak­ing on more risk than they real­ly want to. Baby boomers are mak­ing up for the income they’re miss­ing from bonds while mil­len­ni­als are being put in more aggres­sive port­fo­lios because of their age instead of their risk tol­er­ance.


Learning the Hard Way

Dur­ing and after the Glob­al Finan­cial Cri­sis, many investors learned the hard way the impor­tance of not los­ing big. While they might have clawed back their loss­es over the last decade, 2008 haunts their deci­sions. With good rea­son, the last thing they want is to expe­ri­ence some­thing like that again.

This is why they hire a finan­cial advi­sor: to lessen the impact such cat­a­stroph­ic finan­cial events. So how has this been addressed at the port­fo­lio lev­el?


Failure to Impact: Portfolio Construction and Portfolio Concerns

The shift in investor pref­er­ences since the 2008 finan­cial cri­sis hasn’t seemed to reach the port­fo­lio lev­el, how­ev­er. Many port­fo­lios are allo­cat­ed very sim­i­lar to how they were before the 2008 cri­sis, and this is a prob­lem because many of the asset allo­ca­tion mod­els failed to prop­er­ly pro­tect investors dur­ing the cri­sis.

Using tar­get date funds as a proxy for typ­i­cal asset allo­ca­tion port­fo­lios, let’s look at how three “vin­tages” of tar­get date funds were allo­cat­ed just pri­or to the GFC in June of 2008. The data below is based on Morn­ingstar cat­e­go­ry aver­ages.

2008 Target Date Asset Allocation Portfolios - Fiduciary Insanity - Swan Insights - Swan Global Investments

Source: Morn­ingstar Direct

In 2008, these vin­tages would have been two, 12, and 22 years away from their tar­get dates.  They fall into a typ­i­cal asset allo­ca­tion range, with equi­ties and bonds mak­ing up the lion’s share of the allo­ca­tion.  The more aggres­sive port­fo­lios have a bias towards equi­ty, the more con­ser­v­a­tive port­fo­lios are weight­ed to bonds and cash. This is all stan­dard prac­tice.


Rude Awakening

How did these per­form dur­ing the GFC? The results were quite grim.

2008 Target Date Asset Allocations Drawdowns - Fiduciary Insanity - Swan Insights - Swan Global Investments

Source: Zephyr StyleAD­VI­SOR

The aver­age of the 2000–2010 vin­tage lost over 31% of their val­ue. In the­o­ry these tar­get date funds were sup­posed to be suit­able for investors near or in retire­ment.

The 2020 vin­tage lost over 40% and the 2030 vintage’s loss of 47.7% almost matched the loss on the S&P 500.  It took the aver­age 2000–2010 fund three years to recov­er its loss­es from the GFC while the 2030 vin­tage took over five years.

Of course, all of this assumes no mon­ey was with­drawn from these invest­ments dur­ing the sell-off. If with­drawals were fac­tored in the time to recov­ery would be length­ened.

With these kinds of results, one would expect sig­nif­i­cant changes at the port­fo­lio lev­el, espe­cial­ly for con­ser­v­a­tive investors.

So how have asset allo­ca­tions changed or evolved in the last ten years?

They haven’t, real­ly.

2008 vs 2018 Target Date Asset Allocation Portfolios - Fiduciary Insanity - Swan Insights - Swan Global Investments

Source: Morn­ingstar Direct

The asset allo­ca­tions are almost iden­ti­cal.

Peo­ple may be more risk averse now, but this atti­tude shift isn’t being addressed at the port­fo­lio lev­el.

Investors may have learned the con­sid­er­able impact of large loss­es on their lives, but the indus­try has failed to pro­vide sub­stan­tial solu­tions to these con­cerns.


Alternative Allocations

This is not to say that no one is try­ing any­thing dif­fer­ent. The Cerul­li Asso­ciates[4] study also indi­cates that finan­cial advi­sors are adding more alter­na­tives into their port­fo­lios. As Emi­ly Zulz sum­ma­rized in a recent ThinkAd­vi­sor arti­cle[5], finan­cial advi­sors’ aver­age allo­ca­tions to alter­na­tives rose from 5.7% in 2016 to 7.2% in 2017. This same Cerul­li study states that 37% of advi­sors use liq­uid alter­na­tives and 40% use some form of non-liq­uid alts.

But this still leaves about 60% who are not doing any­thing dif­fer­ent from the tra­di­tion­al stock-bond-cash mix.

More­over, those who do have an allo­ca­tion to alter­na­tives typ­i­cal­ly have less than 10% of their port­fo­lio in such invest­ments.  For those who are invest­ing in alter­na­tives for cap­i­tal preser­va­tion, 10% is just not enough to make an impact. How much pro­tec­tion can one rea­son­ably expect from alter­na­tives if 90%+ of the port­fo­lio is invest­ed in the same old fash­ion? For these strate­gies to make a notice­able impact, they would need 40%, 50%, or more to do the job.


Redefining How We Invest

If tra­di­tion­al asset allo­ca­tion mod­els failed to ade­quate­ly pro­tect investors dur­ing the Glob­al Finan­cial Cri­sis, why do so many of today’s port­fo­lios look indis­tin­guish­able from those from ten years ago?

Rely­ing on tra­di­tion­al approach­es despite their flaws and weak­ness­es is akin to fidu­cia­ry insan­i­ty. Doing the same thing over and over and expect­ing dif­fer­ent results may be detri­men­tal to investors’ port­fo­lios and think­ing bonds will offer the lev­els of pro­tec­tion they have his­tor­i­cal­ly is unrea­son­able to assume.

There are more options than ever before for risk man­age­ment. Uti­liz­ing options-based strate­gies or incor­po­rat­ing hedg­ing strate­gies into port­fo­lios may help address investor con­cerns with cap­i­tal preser­va­tion and advi­sor con­cerns with meet­ing clients’ growth needs.

Investor needs shouldn’t be at odds with how their port­fo­lios are con­struct­ed. With all the 2008 finan­cial cri­sis reflec­tions being pub­lished, this is a good oppor­tu­ni­ty to review port­fo­lio mod­els and finan­cial plans and ask: What are you doing dif­fer­ent­ly to meet client needs and con­cerns?


About the Author

Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Client Portfolio Manager - Swan Global InvestmentsMarc Odo, CFA®, CAIA®, CIPM®, CFP®, Client Port­fo­lio Man­ag­er, is respon­si­ble for help­ing clients and prospects gain a detailed under­stand­ing of Swan’s Defined Risk Strat­e­gy, includ­ing how it fits into an over­all invest­ment strat­e­gy. For­mer­ly, Marc was the Direc­tor of Research at Zephyr Asso­ciates for 11 years.


Important Notes and Disclosures

[1] U.S. Alter­na­tive Invest­ments 2018: Access­ing Evolv­ing Alter­na­tive Plat­forms, Cerul­li Asso­ciates

[2] Near­ly 40% of US Advi­sors Are Using Alter­na­tive Invest­ments: Cerul­li, Emi­ly Zulz, Sept 21, 2018

[3] The Cerul­li Edge – U.S. Retail Investor Edi­tion, 3Q2018

[4] 75% of Investors Pre­fer Pro­tec­tion Over Prof­its: Cerul­li, Emi­ly Zulz, August 9, 2018

[5] Clients Favor Clients Favor Invest­ment Safe­ty Over Per­for­mance … But How do FAs Bal­ance What Clients Want and Need?, Gar­rett Keyes, August 22, 2018

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By |2018-10-04T13:43:12+00:00October 4th, 2018|Blog|Comments Off on Fiduciary Insanity?