Act like an institutional investor

If you are still revisiting risk management strategies for your client portfolios given last year’s downturn, look no further than the institutional side of the business for best practices.

“The last 12 months have probably served to undermind the traditional thinkings of asset allocation,” says Michael Cooke, vice-president of alternative strategies for Invesco Trimark. Cooke spoke Tuesday to a group of 300 advisors attending Invesco Trimark’s Professional Development 2009. “With the exception of risk-free categories like long-term U.S. treasuries or Canadian government bonds, portfolios were down and down significantly in 2008.”

Historically, those who manage institutional clients tend to do a much better job and achieve results with less volatility, Cooke says. That’s because institutional advisors introduce more non-traditional, uncorrelated alternative asset classes to the portfolios in hopes of generate better risk adjusted returns.

Pointing to the Harvard and Yale endowment funds as example, Cooke notes that both have less than 50% of its respective portfolios devoted to stocks, bonds and cash — traditional asset classes. Interestingly, more than 50% are in non-traditional asset classes, notably what Cooke calls “real” assets such as commodities, liquid commodities, real estate and agriculture. Also included are in the mix are private equity and hedge funds. “They do so for hedging purposes against the threat of inflation,” he explains.

While Cooke knows the retail side can’t do everything institutional investors can, he notes that there’s a lot of different investment technology for retail investors that didn’t exist as recently as five years ago.

And institutional investors appear to be holding their investment stance. In the fall of 2008, the Financial Times conducted a survey asking what would be the asset allocation for the next three years. Overwhelmingly, based on the responses, the Times found that “pension funds continue cutting exposure to equities to free cash to invest in alternatives such as hedge funds, private equity, commodities and property … there will be more of a shift away to uncorrelated strategies.”

U.S. consulting firm Greenwich Associates conducted a similar survey in June and 90% of the 152 institutions surveyed have held or increased their asset allocation to alternative investments over the last 12 months. “We think this is a secular trend, it’s not a fly-by-night strategy that investors are applying at the institutional level. That said, one thing they are changing is probably introducing more liquidity to their portfolio for obvious reasons which might involve a modest increase in their exposure for fixed income or cash.”

Of course, portfolio construction is only part of the story. The other part includes reducing the amount of tax paid. As Doug Carroll, Invesco Trimark’s vice-president of tax and estate planning notes, without tax-effective strategies, all the hard work you’ve done for clients will get undone quickly.

While there’s more choice of where to house particular investments than ever before — with RRSPs, non-registered accounts and the new tax-free savings accounts to name a few — more choice can make your job more difficult. Carroll recommends first considering the client’s annual income and his or her tax bracket for the respective province.

And in today’s environment, with impending unemployment still an issue for some clients in a high-tax bracket, it may mean forgoing tax strategies to plan for unforseen expenses. While the RRSP provides obvious tax sheltering, it’s useless if the client is going to have to withdraw the money a year later if he finds himself unemployed, Carroll notes.

(09/22/09)