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For Investors, the “Old Way” is No Longer an Option


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by  Keith McKenzie

When it comes to investment strategy, the times they are a changin’. Low expected equity returns combined with low real returns from bonds has created a financial environment that is no longer friendly to plans created with popular financial planning tools populated with historical returns. As a result, it is very unlikely the investment strategy that got you this far will get you through the next stage of your life.

This new financial environment means that investors must be diligent in designing, constructing, and managing portfolios that not only compensate them for the risks they are taking, but also yield the highest expected return possible on a risk-adjusted, after-tax, and after-fee basis. Failure to do so can result in mounting financial anxieties. In the good old days, when your portfolio was generating high single-digit returns, accepting poorly designed portfolios, paying retail-level fees, and having a laissez-faire management strategy was no big deal. But in the current low-yield environment, with retail portfolios averaging mid single-digit returns, mounting inefficiencies undermine a portfolio’s ability to generate the rates of return necessary to support many existing financial plans.

A Strategic Solution to a Low-Yield Environment

Is there anything you can do to keep your portfolio on track with your financial plan through this low-yield period? Yes. The good news is that when it comes to your portfolio, with the right work and planning, the challenges of the current financial environment can be met. There are five areas where investors can improve their chances and make the mountain seem much easier to scale. These include…

  • Engineering portfolios using an institutional caliber investment philosophy
  • Efficiently leveraging alternative asset classes (instead of hedge funds)
  • Eliminating uncompensated risks and inefficiencies from the portfolio
  • Constructing portfolios using low-cost investment products, avoiding the pitfalls of many index and ETF funds, and
  • Utilizing thoughtful strategies to help reduce tax drag.

For decades, the only asset classes that comprised most portfolios were stocks and bonds. Alternative investments were limited to large banks and institutional investors, who utilized hedge fund structures to layer them into portfolios. One of the key challenges of these investments was that the dispersion among managers, combined with tax inefficiency and high fee structures, resulted in many investors underperforming their internal models for the asset class.

Luckily, there are now real opportunities for regular investors to access alternative investments. The rise of “liquid alternatives” that seek to capture the returns of alternative asset classes (rather than seeking alpha in asset class against similar managers) now provides everyday investors an opportunity to design portfolios with lower expected volatility and slightly higher expected returns. The trick is knowing how to best leverage these new asset classes.

New Building Blocks Require a New Approach

Using institutional caliber investment philosophy is all about strategic and thoughtful engineering. It’s a lot like building a house. There’s a lot of work that must be done before you hammer the first nail. You need to draw up meticulous plans that take into account the purpose and location of each room. With portfolio design, asset classes are your building blocks. It’s important to think about how they work together and what each needs to accomplish as pieces of the portfolio as a whole. In the current low-yield environment, investors are fortunate to have access to more building blocks with the increase of available asset classes. Regular people can do some impressive portfolio design by leveraging alternative asset classes without having to use hedge funds, which are expensive, illiquid, and difficult to engineer around.

In addition to carefully designing your portfolio with institutional liquid alternatives, reducing tax drag is now a strategic imperative for investors. This is an area where investment managers can add value without taking additional risk. It simply requires a thoughtful approach, sophisticated software, and a team aligned to execute on defined tax management goals. This strategy reduces the aforementioned risk-adjusted, after-tax, after-fee basis number substantially. And the results can be more successful than having all the best managers in a portfolio.

That Was Then, This is Now

There was a time, in higher rate environments, when you could tolerate inefficiencies in your portfolio—hidden fees and expenses that basically amounted to rounding errors. These days, though, any inefficiency can be the difference between having an investment plan with a 98 percent probability of success versus a plan that is essentially a coin flip.

The reality is that meticulous engineering that captures risk-adjusted return while minimizing fees and taxes is going to be the price of entrance for portfolios moving forward. In order to take portfolios to the next level and improve the likelihood of keeping financial plans on track, you will need to include as many lowly correlated alternative asset classes as possible. Portfolios need to be constructed with products that are lower cost. They need to be designed in advance with taxes in mind.

The good news is that with careful planning that takes advantage of previously unavailable asset classes, reduces taxes, and minimizes fees, your portfolio is more than capable of weathering the current low-yield environment. As with all financial decisions, taking care to strategically manage the wealth you’ve worked so hard to build can guard against market instability and ensure a retirement that is there when you need it.



Speak with an advisor

There’s no better time than now to protect the wealth you’ve built. Contact us today to speak with an advisor.