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Industry Split on Allocation Models


BOSTON-A chorus of revolutionaries convinced that traditional, growth, value and blend style-dominated asset allocation needs to be replaced by strategic, tactical allocation was quite vocal at FundForum 2010 USA here last week.

But emerging is a group that believes as the economy continues to improve, advisers will return to such traditional models as Modern Portfolio Theory.

For now, large brokerages are offering a combination of the two.

Equities will continue to dominate portfolios, said Dennis Bowden, senior research analyst with Strategic Insight, but asset allocation models are increasingly embracing alternatives and flexible mandates-"and these changing views on asset allocation are putting billions of assets in motion and creating opportunities for sales.

"The U.S. has seen a tremendous evolution of channels and changes in financial adviser and investor demands for new asset allocation models," Bowden said.

"Today, there is more product innovation than I can recollect in 25 years," added Avi Nachmany, director of research and executive vice president of Strategic Insight.

"Uncertainty and doubt in the marketplace is creating demand for new asset allocation models," Bowden said. "In 2009, equity-centric portfolios turned on their head. Financial advisers have changed their views around asset allocation, the way they construct portfolios and their core. Equities continue to be a significant portion of fee-based portfolios, but funds picking up traction have changed, with sales moving to more flexible mandates that can protect on the downside, as well as funds that generate income. This creates an opportunity for fund companies to educate advisers on alternatives."

Mark Staples, managing director of Wachovia Securities, agreed. "There's been a paradigm shift. Investors are looking for a story they have not heard before," he said.

Speakers on the "Fund Selector Showcase" panel said that following the 37% market decline in 2008 and losses in every single mutual fund category, investors and financial planners now believe that static strategic allocation to style boxes no longer makes sense-but major brokerages are offering a combination of new and traditional asset allocation tools.

Bank of America Merrill Lynch, for example, now has a separate alternative asset due diligence organization that identifies changing investment themes, new opportunities and new strategies and recommends 20 to 30 funds that fit these themes to its 16,000 advisers, said Thomas Latta, managing director and head of traditional manager due diligence at BoA.

Likewise, Deutsche Bank's platform now includes all-weather, go-anywhere type funds. "We are offering new, unconstrained managers, but still not moving away entirely from style boxes because some advisers want style boxes," said Gabriel Galvanes, vice president and senior research analyst in the global manager research group at Deutsche Bank.

Post-crisis, LPL Investments has developed a "scenario attribution tool that runs a portfolio against 400 market outcomes, not just quantitative and qualitative analysis," said Gene Goldman, vice president and manager of the strategy group at LPL. "Our analysts also use alternative investments. We think it's a new paradigm. We think we are in a trendless, volatile market where equities will rise only 4% to 6%."

Prior to the crisis, LPL brokers' strategic asset allocation resulted in 10% of a portfolio being turned over each year, he said. Since the volatile market of 2008-09, that turnover has risen to 70% and it is driven by macroeconomic research, he said.

"Instead of buying funds that are top in their asset class, it's top-down selection by exposure to areas we expect to do well. Currently, that's Asia, emerging markets and metals. It's looking at individual pieces rather than the entire puzzle," Goldman said.

"Do you use alternative or traditional methods?" asked Roland Meerdter, founder of Propinquity Advisors. "We think it's not one or the other but a combination through a global macro approach."

But not everyone is convinced that traditional, long-only equity funds will completely fall by the wayside.

"We are big believers in active management and creating value by investing in companies that are growing, can prosper, offer high dividends and real growth," said Jim Jesse, president of MFS Investments. However, if exposure to stocks is packaged more conservatively in outcome-oriented and absolute-return funds, that might convince investors to get off the sidelines and back into stocks, Jesse said. "We have to get away from the idea of 'buying the stock market,'" he said. "In the next 20 years, active will outshine passive but in very complicated categories. The Holy Grail is outcome-orientation," Jesse predicted.

For now, fund flows bear out the investors' current risk aversion. Since the beginning of 2009 through September of this year, investors have redeemed $100 billion from actively managed U.S. equity funds and placed $130 billion into international equity funds and $70 billion into global bond funds, Bowden said.