Biggest Change: The Need to Diversify

Rising correlations of returns across asset classes makes diversification a challenge, said Eve Kaplan of Kaplan Financial Advisors. That's particularly true across traditional asset classes, potentially limiting the risk-reducing benefit of diversification.

Many advisors concur.  Kevin Brosious of Wealth Management, Inc. says "You can no longer use just US bonds and US stocks when building a portfolio.  Long-short funds should be part of the mix, [along with] US and International REITS, Treasury Inflation Protected Securities (TIPS), private equity, International and Emerging bonds." There's no going back to the simple world of U.S.-only investing.  [Ed. Note:  See our recent article on this subject.]

Brosious focuses on asset classes that are available as mutual funds or ETFs. Some advisors are taking diversification one step further. Todd Rustman of GR Capital Asset Management said, "I think the core/satellite approach becomes more and more important for getting alpha outside the normal exposures. We are looking at managed futures and switching more and more to ETFs for the core exposure."

Kipley Lytel of Montecito Capital Management is also broadening his clients' diversification. "We are 45% allocated to alternative asset classes, such as private hedge funds, mutual hedge funds, private equity and other private alternatives.  We hold 10 asset classes, while the traditional investment advisor typically suggests 2-3, like stocks, bonds and REITS.  However, we side with the Harvard and Yale Endowments and fully endorse their institutional approach to weather the current and foreseeable storm." Lytel is motivated partly by a conviction that U.S. asset classes are fairly valued or overpriced based on risk.

Of course, investing in alternative asset classes brings its own challenges. There's not only due diligence, but also the challenge of gaining access to leading managers. Given the capacity constraints on alternative asset managers, there's lots of competition to invest with the best.  [Ed. Note:  See our article on hedge fund investing for advisors]

Adrian Cronje of Wilmington Trust likes investing in alternative assets. He also recommends investing in asset classes that can deliver real sustainable earnings, like inflation-linked bonds, real estate securities and commodities that offer a hedge against inflation.

Inflation and Interest Rates

Speaking of inflation, "We have a nasty combination of plunging interest rates and rising core inflation expenses. This is enough to give any planner and client a migraine," said Kaplan Financial's Kaplan.

Jason Whitby of Investor Solutions believes that "Too many people are trying to retire too young in a low yielding environment with rising costs." This can't work when low interest rates are sapping returns on cash, fixed income, and annuities, especially not when combined with rising life expectancies and inflation. There's no easy solution.

Jeb Collier of D. L. Blain & Co., LLC, said, "Our biggest challenges are the prospects of being in a secular bear market, rising inflation, and low prospects for bond returns."

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