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Breaking domestic bias in client portfolios

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Like many advisers across the U.S., Greg Ghodsi fielded calls from clients worried about their diminished portfolios after markets plunged in response to Britain’s Brexit vote. But those calls, he says, were far fewer than in prior market crises, largely because his clients weren’t looking so much to pull out of global equities. They already were heavily weighted in U.S. stocks.

Ghodsi and his four colleagues, all Raymond James advisers at the 360 Wealth Management Group of Tampa, Fla., work with clients concentrated in domestic equities, some of whom want to keep their money invested primarily in U.S. stocks. But there’s a downside to that domestic bias; namely, what happens to risk diversification? The challenge, Ghodsi says, perhaps worsened by Brexit, is persuading such clients going forward to move to a more internationally diversified portfolio.

“The main reason investors haven’t liked international stocks is that the U.S. has outperformed both the developed international markets and the emerging markets for the last five years in the recovery that followed the fiscal crisis,” he says. “What they forget is if you look back at 2008, we were able to generate positive returns for our clients because of international markets.”

In interviews this summer with advisers at the wirehouses and several of the largest regional brokerages, On Wall Street has heard two common refrains: Investors are telling advisers they want their money invested domestically, not abroad, and they are not enamored with actively managed funds. These sentiments are posing a challenge to advisers who know the importance of stressing diversification to clients.
Getting hard data to support their claims of an investor domestic bias isn’t easy.

As experts at Morningstar explain, neither national nor international fund flow data distinguish between institutional and individual investors and, additionally, most individual money is invested through 401(k) funds, which tend to behave more like institutional investors. Moreover, unlike individuals, institutions have been increasingly interested in investing abroad because of better valuations compared to U.S. equity markets.

RBC Global Managed Strategies Director Dave Quaintance pulled together data from the firm’s clients who use mutual funds to invest in both domestic and global equities. The group of mostly mass affluent investors, he says, numbers in the “tens of thousands.” RBC has 750,000 clients, about a quarter of them individual investors.

The data shows that between 2013 and June of this year, there has been a steady increase in relative allocations to domestic equities and a corresponding decrease in allocation to international equities.

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Quaintance says, anectodally, that this home bias is cyclical, reflecting trends in currency exchange rates.

“As the dollar has increased in value compared to most foreign currencies,” he explains, “investors tend to become more comfortable with investing in domestic equities. They see how even though the companies they invest in have enjoyed a good return, the currencies falling against the dollar negates those gains.”

He also posits that institutions do not react the same way, because they have an easier time hedging currencies, and because they tend to have longer investment horizons and understand that currency variations are cyclical, making them more willing to invest abroad simply based on company performance and growth expectations.

On Wall Street’s latest Global Asset Allocation Tracker also suggests a domestic bias. Allocations to global equities and bonds fell to a record low in the most recent poll of more than 300 advisers. This has put many advisers and clients even more at odds than earlier over whether global equities are a buying opportunity or a sector to avoid.

Read more: Index Global equities: What's the right allocation now?

In the case of passive versus active funds, the evidence is clear. According to Morningstar, over the past five years, the average passive index fund for large-cap core and value stocks gained over 11%, yet fewer than 20% of actively managed funds met or exceeded that performance.

Even in the small-cap category, where active managers can gain some relative advantage, only about one in three active funds outperformed index funds.

Not surprisingly, given that record in 2011, investment money began flowing into passive funds and out of actively managed funds, with passive funds gaining $35 billion and active funds losing $70 billion. By early 2015 active funds saw outflows of $113 billion, while passive funds saw inflows of $75 billion.

“Advisers have the difficult role of trying to overcome these behavioral biases,” UBS portfolio strategist Michael Crook says. “Our task is not to get investors to move 20% of their portfolio into international equities, but to get them to maintain diversification in their portfolio.” As for actively managed funds, he says, “We’re not seeing much pushback from advisers right now. They’re mostly on board with using passive funds. But in the end, I think most clients will end up with some kind of a blend, using actively managed funds in areas where active managers can outperform.”

To convince clients that they are making a mistake by being too U.S.-centric, Sean Pearson, a Philadelphia-based financial adviser with Ameriprise, says he carefully phrases a question. “If you say, ‘Do you want to just invest domestically, or to invest globally, too?’ many clients will answer ‘domestic only.’ But if you ask them, ‘Do you want all your eggs in one basket?’ they’ll say, ‘No.’ The important thing is that you need clients to feel comfortable with whatever they’re doing with the portfolio,” he adds. “If they are just acting on my advice, as soon as something goes down, they’re going to call and say to sell. But if they feel like it’s their decision, not mine, they’ll usually stay invested.”

Mary Ann Bartels, CIO at Merrill Lynch’s investment management and guidance division, argues that a U.S. bias among American investors has always existed. “Ever since I’ve been in this business, U.S. investors have had a domestic focus,” she says, “while if you look abroad, everyone invests globally. We’ve been trying to change this for 20 years, but it’s a challenge. And that’s even though every study shows that going abroad with investments has a positive impact on a portfolio.” Nick Lacey, portfolio strategist at Raymond James, says there’s “a lot of truth” to reports from various investment banks and brokerages about investors wanting to keep their money in domestic stocks, and about a widespread skepticism about once-popular active fund managers. “It’s something we as advisers and strategists have to pay attention to,” he says. “We know what investors should do with their portfolios, but sometimes that conflicts with what they want to do because investors generally want to do what has worked in the past.”


Lacey, who provides advice to Raymond James’ stable of financial planners, suggests that they start by asking their clients, “How much are you comfortable with owning outside the U.S.?” He explains, “Most firms default to one-third of assets outside the U.S., and that’s probably more than what most investors in the U.S. are comfortable with, especially because we’re in an environment today where the U.S. has been the best place to put your money. Advisers need to say now to clients, ‘You know, the probability is that the U.S. is not going to continue to be that best place to invest, given the already high valuations here.’”

He says Raymond James currently recommends a 25% allocation to global assets.

“I don’t know what the investor response is to that,” he notes. “Each adviser is different, but we’re telling them all not to have clients holding zero foreign equities.” As for the active vs. passive debate, he says Raymond James is big on blending the two in a portfolio, adding that even if passive funds have done better at any given time, there are usually active managers outperforming the indexes.


Debbie Sullivan, an adviser with RBC Wealth Management in Pittsburgh, says she gets plenty of investment clients who favor investing domestically. Some, she says, are people “from the World War II generation” who have always felt more comfortable investing domestically. But lately, they’ve been joined by younger clients. Partly, it’s that U.S. equities have been doing well, and partly it is concerns about economies abroad — the Eurozone with its Grexit and now Brexit crises, the unrest in the Middle East, etc. But she says, “Our job as advisers is to explain to people that they’re wrong, that in developed countries abroad there are a lot of young people who are making more money than young people in the U.S., and they need to be in those countries.”

She feels similarly about the current investor reluctance to include actively managed funds in their portfolios. “I’m not a proponent of passive investing,” she says. “It’s true people like passive funds and ETFs because they’re cheap, but if you look at good active managers, even those who charge a lot, they’re in those funds themselves.” She says that by using actively managed funds, they attempt to reduce risk and still deliver market-like returns.

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RBC’s Quaintance says an array of new investor concerns is driving portfolio construction trends. “Yes, people are still scared of investing globally — in fact, they’re almost at an extreme in their focus on only domestic equities,” he says. “We’re hearing a lot of clients saying that they want less global exposure, and that’s even though it’s gotten easier than ever to currency hedge.”

But Quaintance says he has not seen much opposition to active management. Instead, RBC investors are more willing to mix it up. “You used to see people pick a side — active or passive — and go with it. But now we find both advisers and clients getting more open to combining the two approaches.”

Another trend he has seen is a preference for liquidity in portfolios and increasing interest in alternatives. “This interest in liquidity is across the board,” he notes. “Even with private equity investments, which we’re also seeing more interest in, we’re seeing people look for shorter return periods, like a five- to seven-year payout instead of the old 15-year norm.”

For investors, transparency is important; for advisers, it’s “regulatory issues, such as fees, liquidity, suitability and the new fiduciary rule.”


Thinking in terms of why investors may have certain investment preferences can help an adviser steer them into a more beneficial direction, argues Michael Liersch, head of behavioral finance at Merrill Lynch. For example, a client who is concerned about investing globally may have a time horizon that is relatively short, and cash-flow needs that are driving that concern. “Just looking at one aspect of an investment preference can cause the adviser and the client to lose sight of the key things that matter to the client,” he says.

On Wall Street discovered one other trend in portfolio management that most institutions had in common: a significant increase in investor interest — especially among younger clients — in ensuring that their investments are socially responsible, or even that they are helping to advance some goal through their investment. “We see this trend being led by young, by female and by wealthy investors,” reports Jackie Vanderbrug, investment strategist for U.S. Trust. “If you look at millennials, for example, 93% say that the social impact of their investments is important to them. Even among all investors, 50% are saying social concerns are important. In fact, the percentage is so high you might say to advisers, ‘Why aren’t you asking about this?’” Yet she says only one in five advisers typically has that conversation with high-net-worth clients. A big difference that is likely to be increasingly coming to the fore as millennial investors grow older and increase their assets, she says, is in how they perceive their wealth. “Historically investors have not seen their portfolios as part of their identity,” she says, “but younger investors do see things that way.”

Liersch agrees. “Purpose-driven investing is becoming extremely important. We see millennials very focused on articulating their values in their investment goals and wanting those values to drive their investments.”

“Of course, younger investors don’t have that much money yet,” says RBC’s Sullivan, “but this concern with social responsibility is probably going to stay with them as they get older, and it will become increasingly important.”


For his part, Raymond James adviser Ghodsi says he hopes to keep his clients at ease by sticking to his firm’s cautious approach to any changing investment climate.

“We have six basic asset categories: fixed income, commodities, U.S. equities, currencies, international equities and cash,” he explains. “We change the balance over time, but generally we do that pretty slowly. Six months ago we lowered U.S. equities from the No. 1 position to No. 3 after bonds and commodities. We don’t like to be leaders. We look for confirmation of a trend and then we make a move in or out of an asset. We don’t get all the potential gains that way, but we also reduce the risks,” he adds.

Ameriprise’s Pearson still believes in diversification as the best way to manage risk. That means diversifying beyond U.S. equities and recognizing that active and passive funds both “have their place” in a portfolio.

As for RBC’s Sullivan, she says, “In general, our clients look to us for advice, but even if they have crazy ideas like wanting to only invest domestically, or not wanting any actively managed funds, if I can sway even partially what people want to do, I feel good.”

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