32 INVESTMENT ADVISOR OCTOBER 2019 | ThinkAdvisor.com
positive and negative — it’s hard to argue
J.P. Morgan Asset Management found
that in the 15 years through the end of
2017, private equity generated a 14.4%
net annual return versus 8.8% for the
MSCI World equity index. Like other
alternative asset classes, it can be an
effective diversifier that can generate
solid relative returns.
Indeed, recent research from
Georgetown University’s Angela Antonelli
found that including even a conservative
private equity allocation in retirement
strategies can increase median retirement
income by 6% (or higher) for certain
investors. Importantly, improvements in
downside protection also were reported.
Traditionally opaque about its inner
workings, private equity is growing
more transparent, driven by asset managers’ desire to reach mass-affluent
investors. Advisors who are looking to
allocate more funds to private equity
also face fewer operational barriers to
entry than in previous years.
Ultimately, the current market environment presents an opportunity for advisors
to revisit the benefits of including alternative investments in a properly diversified
portfolio, potentially leading to lower volatility, higher risk-adjusted returns and,
consequently, more retirement income for
the investors with whom they work.
Advisors considering the use of alternatives should ask who might benefit from
a particular solution. Further, a thorough
look at the underlying investments —
what they are and how they work — is
central to the due diligence process.
It’s critically important to explain
the recommended asset class, potential risks and rewards, the tax structure
and fees, and to clearly set expectations
to avoid unwanted outcomes. Between
the investment manager and other
third parties that specialize in alternative investments, there is a wealth of
resources available to help.
Justin Fay is a director within Global
Strategy and Product Management for
BNY Mellon’s Pershing.
How to Save Portfolios in a Bear Market
Retirees who pay expenses from their portfolios can get a double
whammy when markets drop.
Bear markets are a fact of financial life, but they’re riskier for those who are close
to or in retirement. Retirees who pay expenses from their portfolios can get a
double whammy: not only do they lose principal due to the stock market drop, but
the depletion in savings cuts into the portfolio’s ability to rebound.
To determine how to “mitigate” this problem, UBS Financial Services designed
the Bear Market Damage Index, largely “to assess how much portfolio depletion
risk is [in a portfolio],” Justin Waring, investment strategist Americas for UBS,
told IA. He authored the study with Michael Crook, head of Americas investment
strategy for UBS.
That a diversified portfolio reduces risk is nothing new, but beyond that UBS
suggests a “liquidity longevity approach” to prevent a bear market from taking a
larger bite out of a retirement portfolio.
This means having a separate cash/short-term instrument account that “meets
cash needs and keeps the lights on, and doesn’t expose savings capital,” Waring
explained. It should be enough to last 74 months, which takes into account a market drop, plateau and rise.
However, to do this advisors must know a client’s lifestyle expectations and
cash flow needs.
To calculate a portfolio’s BMDI, UBS runs “a simulation of the portfolio’s value
after withdrawals up until the end of the longest-ever bear market window,” the
paper states. This means BMDI is calculated as a percentage of the portfolio’s
depletion, indexed to 100.
The example provided by UBS is of a client with a $1 million all-equity portfolio
that experienced a 51% drawdown over a three-month period, as well as spent 22
months at a plateau before beginning a 49-month climb back to a new time high.
That means the time from peak to peak is 74 months.
A liquidity strategy would mean, in this example, an ending portfolio value of
$741,617 vs. $583,511 if the client would have to withdraw from a portfolio’s capital, according to UBS.
A sufficient liquidity strategy is one way to manage a portfolio in a bear market, but
also, as almost every advisor knows, a “healthy allocation to bonds” mitigates losses.
Whereas on one side of the scale, 100% equity holdings, there would be a 51%
loss, 100% bonds would be a 3% loss. But as the paper notes, “taking too little
risk can cause just as much damage as taking too much.”
A mixed portfolio of equities and bonds definitely mitigates risk, but another
idea is to borrow to meet cash needs as opposed to pulling funds from portfolio
capital. Waring notes too that “interest rates are lower during bear markets.”
This would allow clients to meet some of their cash needs and “manage bear market
risk with less opportunity cost (foregone gains) during bull markets.” —Ginger Szala