By David Wismer, Flexible Plan Investments
Each year, Proactive Advisor Magazine publishes reviews of major trends in the wealth-management industry, especially those related to managed investment accounts; the use of third-party investment managers; and viewpoints on active, risk-managed investment strategies.
I want to share a part of one of these overviews that I think is particularly relevant in an investment environment where market volatility has picked up once again. (As we have seen in recent weeks, volatility often cuts both ways—to the upside and downside. Many studies have shown how the “best” and “worst” days in the market often cluster together.)
Most of the analysis I have seen indicates the current volatility is being driven by uncertainty over the path of future Federal Reserve actions; the emergence of the omicron variant of COVID; and ongoing concerns about economic growth in the face of the pandemic unknowns, inflation, and supply-chain issues.
To this point, the Cboe Volatility Index (VIX) spiked to over 30 last week, the highest level since January 2021.
The debate: Active vs. passive—or both?
Why is the data regarding market volatility particularly relevant for financial advisers and their investor clients—especially over the 2020–2021 period and moving forward into 2022?
Several recent research reports have found that financial advisers are turning increasingly to active investment strategies for their clients—particularly those strategies with a strong risk-management focus.
An independent research study sponsored by PGIM Investments and published in 2021 explored adviser concerns and trends in portfolio construction in the current investment environment. This has helped inform their overall conclusion that “advisors are relying heavily on active strategies in guiding clients through this period … as they seek to capture outperformance opportunities and mitigate portfolio risk. … As we move forward, advisors are aiming to build flexibility and resilience into client portfolios through a diversified mix of active and passive strategies.”
The study’s top-line findings include the following:
• “Stock market volatility remains the top concern (68%) for advisors today, along with the potential impact of an economic slowdown (43%) and a low-return environment (41%). …
• “The COVID-19 pandemic is influencing portfolio construction. Most advisors (76%) say COVID-19 has impacted portfolio construction in 2021, specifically when it comes to how they think about economic/macro trends, asset allocation strategy, and sector preferences.
• “Advisors say managing risk is their biggest portfolio construction challenge. …
• “Advisors rely on active management but say passive strategies have their place. … The majority of client assets are allocated to actively managed investments (62%), with a third (34%) in passive investments and the remainder (4%) in cash or cash equivalents.”
The following two charts, based on the study’s findings, examine (1) key success factors for active managers in the eyes of financial advisers and (2) the types of market environments they believe favor either a more active or more passive approach.
Consistent with the themes of the PGIM report, a study conducted by The Journal of Financial Planning and the Financial Planning Association (FPA) showed that 76% of advisers’ clients actively contacted them about market volatility in 2020, and 52% have done so in 2021.
The net effect of this, according to that same FPA study, has been a shift toward considering different portfolio approaches. In the March 2021 study, 74% of advisers said they had reevaluated the asset allocation they typically recommend or implement within the prior three-month period. This was largely driven by concerns about the state of the economy and/or market volatility experienced over the prior year.
The study concluded, “The majority of advisers (58 percent) continue to favor a blend of active and passive management, as has been the trend for the past several years. However, the 2021 results show a continued decline in a purely passive approach.”
In an October 2021 article from Morgan Stanley titled “A New Take on the Active vs. Passive Investing Debate,” the author, a senior investment strategist, provided the following perspective in line with the findings above:
“… I spend a lot of time thinking about how to construct investment portfolios—and these days, a big part of that conversation centers on the role of active and passive styles of investing, an ongoing (and sometimes quite heated!) debate in the financial industry. …
“Active strategies have tended to benefit investors more in certain investing climates, and passive strategies have tended to outperform in others. For example, when the market is volatile or the economy is weakening, active managers may outperform more often than when it is not. Conversely, when specific securities within the market are moving in unison or equity valuations are more uniform, passive strategies may be the better way to go.
“Depending on the opportunity in different sectors of the capital markets, investors may be able to benefit from mixing both passive and active strategies—the best of both worlds, if you will—in a way that leverages these insights. …”
The bottom line
In general, financial advisers we have interviewed for Proactive Advisor Magazine tell us that third-party money management—with a focus on risk-managed portfolios—has provided the following benefits for their practice and their clients:
• Enhanced risk management/diversification.
• Mitigation of market volatility.
• Sophisticated, rules-based strategies that take emotion out of the investment equation.
• A turnkey approach to strategy implementation and execution.
• Professional investment management that frees up their time for client planning and service.
• A greater degree of “behavioral adherence” on the part of their investor clients to stick with their long-term investment plan through full market cycles.
I believe the research cited above and the extensive feedback we have heard from financial advisers is quite consistent with the overall investment philosophy endorsed by Flexible Plan Investments (FPI) and discussed frequently in this space.
Jerry Wagner, FPI’s founder and president wrote recently,
“Our strategies are designed to use activity to provide another layer of risk management that passive portfolios cannot deliver. In addition, combining these strategies or adding them to a passive portfolio can result in diversification that exceeds the preventative care attainable by a portfolio diversified only by asset classes. … Dynamic risk management and strategic diversification are today’s prescription of choice to prepare for and heal from unpredictable times.”
