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How to help clients understand non-correlation

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As alternative investments gain ground, financial planners may mention non-correlation as a prime benefit. By zigging when traditional asset classes zag, alternatives can reduce overall volatility and perhaps shrink clients’ stress levels as well.

However, non-correlation can be a mixed blessing in bull markets. When the broad U.S. stock market rises more than 30%, as it did in 2013, clients may decide they love correlation; why bother with an alternative investment when times are good? Advisors who believe in alternatives might have to explain their tactics.


“One way that we deal with this is to show clients a periodic table of returns,” says Stephanie Lang, chief investment officer at Homrich Berg, a wealth management firm in Atlanta.

This table, produced by firms such as Callan Associates, shows year-by-year comparative results for multiple asset classes. Each asset class has its own color, so clients easily can see how relative performance bounces around, from year to year. (Oppenheimer Asset Management calls the “Dashboard Edition” of its table the “asset quilt.”)

“This table demonstrates that no one can be sure about short-term returns,” says Lang. “We tell clients that’s why we like to diversify. Equities have done well, over time, but some years there’s a downside.”

The latest Callan table, for instance, shows the S&P 500 in the upper half of asset class returns in the last three years but also reminds investors that this index ranked 8th of 10 listed investment choices from 2001 through 2004, followed by four relatively strong years and then two years back down to seventh place.


With this visual evidence, advisors at Homrich Berg can keep clients from focusing too heavily on keeping up with the equity markets during years they rise sharply. “We can point to times when stocks sold off,” says Lang, “and demonstrate to clients the benefits of diversification in helping them avoid capturing all of the downside.” With a smaller loss, it’s easier to recover from a stumble and regain upward progress.

Lang says that her firm includes alternatives in clients’ portfolios for both risk reduction and potential rewards. “Our alternatives include some liquid holdings, such as hedged mutual funds, REITs, and master limited partnerships,” Lang adds. “We also have illiquid alternatives for selected clients, including traditional hedge funds.”


For clients who can tolerate extended illiquidity, Homrich Berg puts together private funds-of-funds. “Clients know they won’t see a redemption for some time,” says Lang, “usually six to 10 years. They may get cash flow in the interim, from private lending to proven companies as well as oil and gas investments, for example.”

Such private illiquid alternative funds are offered about every two years, and suitable clients are urged to participate regularly. “Some years turn out to be better for these investments,” says Lang. “Investing in several of these funds provides diversification by vintage years.” Such diversification may make the long-term path to achieving goals smoother, and keep clients from focusing too heavily on short-term fluctuations.

Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.

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