Option Trading: How Important is Asset Allocation? Part IV

Synopsis: Discussing a Wall Street Journal article from Apr 29, 2009.  It's written by Anne Tergesen and Jane J. Kim. 

Advisers Ditch 'Buy and Hold' For New Tactics

Facing Angry Clients, Pros Turn to 'Alternative' Products; Risk of Missing a Turnaround

"The broad decline across financial markets in the past year has
persuaded a small but growing number of financial advisers to abandon
the traditional buy-and-hold strategy — which emphasizes long-term
investing in a mix of assets — for a new approach geared to sidestep
future market plunges and ease volatility."

Another mention that professional advisors are moving away from traditional investing styles.  Now 'buy and hold' joins 'asset allocation.'  It's not true that everyone is discarding these time-honored methods for risk reduction, but what was once considered to be gospel is losing adherents.

"an adviser… used to counsel
clients to buy a diverse menu of stocks, bonds and commodities, and
hold on for the long run… Today, … [he] keeps about 90% of his clients' money in such
low-risk investments as short-term bonds, cash and gold. With some of
the small amount that's left over, he uses leveraged exchange-traded
funds to place magnified bets both on and against the Standard &
Poor's 500-stock index."

90% in Bonds, cash and gold.  I love the fact that this financial advisor was thinking outside the box and was truly trying to help his clients.

As I said, a noble attempt.  Unfortunately the advisor made a big mistake when buying leveraged ETFs.  Those vehicles are designed strictly for day traders and holding them for longer periods lessens the investor's chances of earning a profit. Adam Warner writes the Daily Options Report and has made a significant contribution with his reports on why owning leveraged ETFs is a losing proposition.

"Buffeted by steep declines in stocks, many bonds, commodities and real
estate, many advisers are questioning their faith in long-standing
investment principles, such as controlling risk by building diverse
portfolios. Some are adding increasingly exotic investments, including
products that offer downside protection, to client portfolios. Others
are trading more actively — and say they plan to continue to do so
until they see evidence of a new bull market."

'Trading more actively.'  There's no other way to interpret those words.  Some advisors are now attempting to time the market.  It's almost beyond belief. One of the most sacred tenets of professional financial advisors is that it's extremely difficult to out perform the market by timing trades.  Yet, here they are: abandoning buy and hold.  Giving up on asset allocation.  Timing market buys and sells.  It seems these advisors will be trying anything to salvage their clients accounts.  Well almost anything…options are barely mentioned in this article.

"By abandoning time-proven prudent techniques, they run a serious
risk of destroying their own credibility and their clients'
portfolios," says…an independent financial advisory firm that
still practices buy-and-hold investing.

The changes come at a time when financial advisers are coming under
pressure from clients who are tired of paying fees only to watch their
savings evaporate. Advisers have "a lot of cranky clients."

And they should be cranky.  Clients don't expect miracles, but when paying fees for professional advice, they don't expect to under-perform the market.

"some are adopting even less-conventional approaches in an attempt to
more effectively offset the risks of investing in stocks… Others are turning to
"structured products," which are complex investments that often employ
options to provide downside protection. Still others are using
investments such as currencies or managed futures that they believe
will rise when stocks fall."

Options?  Did she say options?  Unfortunately there is this statement later in the article: "Such products typically come with high fees and employ investment strategies that can pose complex risks."  Options are finally mentioned as an alternative, but are soon dismissed as involving high fees and 'complex' risk.

Then there's the last sentence of this article: Advisers are using items they believe will move in the opposite direction than stocks do.  Amazing.  Isn't that the entire purpose of asset allocation?  Are these advisors trying this for the first time now?  Something must be lost in the translation.

Another advisor is quoted: "Asset allocations built on stocks and bonds are best suited to secular
bull markets… but the past nine years have proved that
nontraditional thinking makes more sense in secular bear markets."

I could not agree more.  Almost anything works in a bull market, but it's the bear market from which investors need to be protected.  My suspicion is that the professionals who collect commissions and fees from their clients always knew this and were happy to take feels when everyone was happy.  But it's been quite awhile since investors have been happy.  Traders can make a living in any type of market, but trading is for the few and investing is for anyone who can save a little money on a regular basis.  Those people need help.

"Other advisers are looking even further afield for alternative
investments… is also recommending greater
exposure to alternative investments, including managed-futures funds,
bonds that back construction and expansion projects at churches,
hedge-fund-like mutual funds, gas-drilling projects, and private
partnerships that invest in real estate. He also holds positions in two
private partnerships that invest in railroad cars."

To me, this is scary stuff.  Railroad cars?  Illiquid investments?  These advisors go pretty far to avoid using options.  I do not understand why this is true.


4 Responses to Option Trading: How Important is Asset Allocation? Part IV

  1. MachineGhost 07/20/2009 at 6:18 AM #

    Good stuff. But to complete the series, how about giving various examples of how “easy” it is to actually hedge a stock portfolio effectively, as well as the various pitfalls to watch out for.
    On a more general note, if past history is any indication, I think you might have unrealistlc expectations about the financial system. The institutional incentives are just not aligned towards generating mavericks that think outside the box. To a very large extent, the system doesn’t care one whit about making clients money, but making themselves money. They’ll only grudgingly respond once clients get “cranky” and that is usually short term… remember all of the “principal protected” mutual funds that came out after the dot.com bubble? But, stupid is as stupid does. Stupid clients won’t take financial matters in their own hands and subsequently pay the price for outsourcing. Your time could be far more valuable spent in educating the stupid graduates and not being frustrated with the continuing stupid and their parasitical supporters.

  2. Mark Wolfinger 07/20/2009 at 12:27 PM #

    MG, You made me laugh. But you have offered some excellent advice.
    I keep attempting to achieve the same goal by using the same techniques and expect (hope) to achieve a different result. That is known to be a wasted effort.
    I guess what I’m trying to do is encourage others to see the errors of their ways, but I certainly don’t want to be compared with a missionary.
    I’ve already given simple examples of how to hedge a portfolio consisting of ETF investments: http://tinyurl.com/m5d4a3; http://tinyurl.com/ngrj9r
    The decision for each investor is selecting which put to buy and call to sell. That could make an interesting post.
    It’s the same with individual stocks, except that you add a collar for each stock. That may be too much of an effort – if you own too many stocks. I hope it wouldn’t be, but each investor has to decide how much effort a protected portfolio is worth.

  3. Donald W 07/20/2009 at 4:46 PM #

    Guess we all have seen which groups have fail to protect their clients over the last year. Amazing, those who tauted stocks the loudest all of a sudden became the quietest. Of course, now that the markets are going back up..new experts and told-you-so are appearing all over the internet again. Think I will stick to learning Options to protect me from now on and ignore those pro’s. No more trying to retire in just 5 years. Errors learn and smaller profits with RISK MANAGEMENT is my new game plan. Thanks for the articles Mark!

  4. Mark Wolfinger 07/20/2009 at 11:09 PM #

    Risk management is the whole ballgame.
    There is nothing new in the fact that the people who got it wrong shut up for awhile, then begin yelling again. Those who shout the loudest about their current guesses have the best chance of having people forget their past mistakes.
    We see in on TV all the time. No one takes responsibility for calling bottoms that aren’t really bottoms. Make enough calls, and you’ll eventually call the real bottom. Then they boast about how smart they were (once), ignoring all the bad calls..
    The professionals have hurt the novices, but the novices have nowhere to turn, except to other professions who have one goal – to take money from the novices in the form of fees and commissions.
    Very sad.
    It’s a sad mess.