How wealth managers are tackling portfolio management in a market downturn

There hasn’t been much good news lately to share about the market, and the economic outlooks for 2023 aren’t much rosier.

The International Monetary Fund is just one of many institutions with unpleasant predictions for next year – its latest World Economic Outlook report pegs global growth will cool to just 2.7%. “The worst is yet to come, and for many people, 2023 will feel like a recession,” the IMF report stated. 

Investment leaders at advisory firms across the country say they are busy acting for their clients in the current market climate and preparing for additional challenges in the New Year.  

“One market factor advisors have been reacting to and say will continue to persist in 2023 is the threat of continued increases in interest rates. Either due to inflation continuing or outright increases from the Fed,” said Stephen Kolano, managing director of investments at Integrated Partners, a national hybrid RIA firm.  

Another is the potential for a recession and slowdown in the overall economy due to inflationary pressures. (A Bloomberg survey of 42 economists put the probability of a recession over the next year at 60%.) 

“Many of the best performing sectors in the past few years are very sensitive to a slowdown in growth and increasing interest rates, and as a result, those sectors may not perform well going forward,” Kolano said. “So, positioning client portfolios going forward becomes much more challenging and uncertain given the transition that is taking place in the global economy.” 

Kolano said his firm is choosing to be shorter duration in its fixed income portfolios as they are less sensitive to changes in interest rates. 

“We prefer inflation-sensitive asset classes to defend against further inflation and inflation expectations increases. We also are increasing exposure to inflation-sensitive fixed income, such as TIPS. In growth-oriented portfolios, we are looking to more defensive areas of the economy such as energy, health care, and consumer staples where prices are more easily passed through to the end consumer and there is less elasticity of demand.” 

Wealth managers and their clients will also be mindful of the impact of the midterm elections and a divided government on their portfolio management strategies.

“Markets historically do reasonably well during periods of gridlock in Washington, said Gerald Goldberg, chief executive officer of GYL Financial Synergies in West Hartford, Connecticut. “But the inflation rate and the Federal Reserve’s policy response will be far more impactful to investors’ portfolios in 2023.” 

Kolano agreed.

“Investors should expect the political landscape in the U.S. to bear little impact on longer-term portfolio returns,” he said. Nonetheless, investors should “remain aware” of two developments that intersect with politics, Kolano added: whether Congress lifts the debt ceiling to fund the government next year and whether political pressure will influence the Federal Reserve Board’s fiscal policies regarding inflation. 

“The bigger issue investors may want to pay attention to that could impact their portfolio returns would be the geopolitical landscape in 2023 and beyond,” Kolano said. Rising tensions resulting from Russia’s war with Ukraine and China’s goal to annex Taiwan “have the potential to impact longer-term portfolio returns,” he warned.

At Anchor Capital Advisors in Boston, one portfolio action for clients has been tax loss harvesting, said Stephen J. Cavagnaro, the firm’s director of private clients. 

“Given the amount of different, yet very similar investment options in the market today, advisors should be able to arrange taxable portfolios in such a way as to offset gains and potentially create loss carryforwards,” he said. 

Cavagnaro added it is worth going through the exercise with clients on converting traditional IRA assets into Roth assets, “assuming they can pay the taxes outside of the retirement accounts for maximum benefit. While assets values are depressed, this offers a unique way to grow assets tax-free throughout their life and beyond.”

 The firm isn’t drastically revising expectations on equities over ten years, Cavagnaro said. “But in the short-term, there will almost certainly be additional challenges. On the bright side, fixed-income rates of returns have been dramatically revised to the upside from this point and may continue to have some room to run. It’s been a long time since you could count on your bond portfolio to contribute meaningfully.” 

Gene Balas, an investment strategist at Signature Estate and Investment Advisors, a national RIA, argued that if a firm has clients in their respective proper strategies, managing expectations can be more important than managing portfolios in challenging environments. 

“Messaging to clients is essential – whether during one-on-one client meetings or through broad communication channels – that bear markets are, in fact, natural and normal, and, at least in the past, they have occurred much more frequently than they have in recent years,” Balas said. 

Counseling clients during market downturns can reinforce the original reasons why they are in a particular strategy, Balas added. 

“Clients may need a reminder that to achieve gains during up markets; one will likely experience losses during down markets; it is nearly impossible to have it both ways. That said, market downturns are an excellent opportunity to review with clients whether their personal circumstances continue to warrant their existing portfolio strategy.” 

Of course, it’s not only clients who might be feeling anxious. For advisory firms who have not operated through a sustained down market, the investment experts offered their lessons learned from experience. 

“Markets respond to investors’ perceptions of fundamentals, as well as to their fears,” Balas said, offering patience as his advice. 

“Each bear market is different, caused by unique factors and ends with their eventual resolution. The horrendous plunge in the markets that began in October 2007 suddenly reversed in March 2009, when the Fed and the U.S. federal government announced monetary and fiscal stimulus. As investors’ optimism solidified, a great bull market began – months before the recession was even over. Waiting for the economy to rebound would have caused an investor to lose out on the considerable gains that followed for years afterward.”

As for the impact of the midterm elections, Balas noted that a divided government has historically meant stability in the markets.

“Divided government may help prevent actions by either party that can introduce uncertainty, whether it be about the Treasury’s borrowing needs, tax law changes that can unfavorably affect corporations or their customers, or introducing new and potentially more onerous regulations,” he said.

“Investors may find that there is no need to change portfolio positioning – assuming that it is otherwise suitable – in response to the election results,” Balas counseled.

For Kolano, disciplined planning is key. 

Understanding clients’ near-term needs and goals and structuring their overall portfolio and financial plans that allow them not to have to sell when assets are down is a strong defense and can enable clients to take advantage of shorter-term dislocations in the market that may persist for a couple of years.  

Kolano added that firms should grasp the dynamics of why markets may decline to anticipate how portfolios may behave as part of a disciplined risk management process and work to develop portfolios to be resilient across multiple time horizons. “Keeping clients focused on long-term goals and perspectives is also crucial to keep them invested and able to take advantage of opportunistic moments in markets through dollar cost averaging and consistent discipline,” he said. 

Cavagnaro’s advice to young firms is that they should take the opportunity now to understand clients’ risk profiles fully. 

“When risky portfolios are going up, nobody says a word, but when that turns around, conversations become quite a bit harder,” he said. “Helping clients work out achievable goals and then building a portfolio to meet, or slightly exceed those goals, with the least amount of risk creates a better long-term solution for both the advisor and investor.”