Talking with your clients about investment strategies may not be easy given the current economic climate, but preparation and ongoing assessment of an investor's portfolio are the keys to restoring confidence. Money managers agree that mutual funds continue to be a strong investment vehicle, offering investors a number of options for accessing the market - that is, if they stick with their investment strategy.
"Most of my clients now are scared and still concerned if you mention the word equity," said Tom Roche, a CPA and partner at Fazio, Mannuzza, Roche, Tankel, LaPilusa LLC in Springfield, N.J. "The No. 1 thing that people say is, 'I haven't looked at my statements. I haven't had the guts to open them in the last few months.' A lot of people don't even want to talk about it now."
Roche, who offers wealth management through FMRTD Financial Resources LLC, said that he's still been using mutual funds quite often within his clients' portfolios because of the diversification they offer. "We put a lot of money into money markets over the last year because we were hesitant to be investing in equities or bonds," he said, while adding that he would re-adjust his clients' investments over the next few months. "Everything has been down across the board."
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Mutual funds are composed of individual securities, so it makes sense that their returns are reflective of what's going on in the market, according to Philip Brice, principal of Elliott Davis Investment Partners in Greenville, S.C. When investors begin pulling money out of funds, it could put added selling pressure on the fund manager in the short run at times when they may not want to sell a particular security.
Nevertheless, mutual funds are a great way for investors to access various segments of the market, Brice said. He suggested creating a blended portfolio of mutual funds and exchange-traded funds that represent various asset classes such as growth, value, large cap, small cap and international, and that complement, rather than overlap, each other. ETFs are traded investment vehicles that hold a "basket" of stocks or bonds and trade at the approximate value of the underlying assets.
Staying disciplined
The consensus among financial experts is that mutual funds are showing many investment opportunities, despite the volatile market - and it isn't in just one category.
According to Andrew Gotfried, director of mutual fund research and marketing at financial services concern Raymond James, various types of infrastructure-related funds look opportunistic, as well as the more mainstream categories that have experienced significant performance declines, such as the muni high-yield space.
"It is imperative that financial advisors and individual investors understand the products," Gotfried said.
Using the S&P 500 as a market benchmark, he said that it is evident that many funds, more than half in some categories, are not holding up to the market - which was down about 40 percent last year. "Look at the large cap blend in the Morningstar ranking category, in which there are currently 2,312 funds. Of those 2,312 funds in that space, the S&P is beating almost two thirds of them."
Gotfried explained that there are several reasons why this is happening - mainly, there are the redemption challenges that many portfolio managers face, as well as managing style and risk. He said that many funds maintain a cash level that is designed to meet their redemption obligations. In the current environment, where many investors are uncertain and pulling out, the funds have to increase their cash positions and investors are missing out on opportunities they might pursue, according to Gotfried.
"Given the volatility we're seeing and how individual financial advisors and investors are trying to view the funds relative to the market, some portfolio managers are faced with a decision to either change their style to compete with the market or stay pure with their strategy," Gotfried said, adding that low-turnover deep-value managers are a good example of this. "When you see them stick to their discipline, they may begin to show poorer-than-average performance against their benchmark. But the reality is that they are doing what they say they are doing."
His firm has also been incorporating funds that offer alternative strategies, such as convertible bond funds that own bonds with the option to convert to equity in the underlying company. Another choice is merger arbitration funds, which specialize in M&A.
"Many new alternative strategies are available and are becoming an important part of controlling risk in the overall portfolio," Brice said. "They're also completely regulated, transparent and liquid, which in times like this is very important in monitoring results for our clients. We have a very rigid process that helps identify the best funds in each one of those categories. You want a methodology of evaluating those on a regular basis. It's important to make sure you've got good investment options up front and that they remain the best in those particular asset classes."
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