Changing market dynamics and investor attitudes have persuaded some financial advisors to take a more flexible approach to the asset allocation in their clients’ portfolios.

Typically, advisors will use different approaches to asset allocation but with a common goal in mind — to select the mix of assets that will generate the highest possible risk-adjusted rate of return, taking into account their clients’ investment objectives, risk tolerances and time horizons.

Although many advisors use the traditional, structured long-term strategy, which involves varying the mix of equities, fixed-income and alternative investments within defined target ranges, others resort to more unorthodox methods.

Essentially, the latter group uses a technique that entails more frequent changes in asset mix to take advantage of market movements, as well as specialty asset classes to boost returns. This could include overweighting sectoral mutual funds, hedge funds or “absolute return” funds.

“Asset allocation should not be based on a rigid structure; it should be a fluid process,” says Kevin Sullivan, vice president, portfolio manager and advisor in Toronto with Montreal-based MacDougall MacDougall & MacTier Inc. The traditional long-term, buy-and-hold strategy, he says, was “tossed out of the window years ago.”

A fluid approach appears to be more in keeping with shifts in client attitudes in the wake of increased market volatility and uncertainty. In recent years, says Sullivan: “Sentiment and psychology have been responsible for 75% of market movements.”

Arguably, many clients are disenchanted with the markets. “The bluest of the blue-chips blew up in an unprecedented way,” says Sullivan, causing clients to change their attitudes toward sectors that were traditionally seen as relatively safe havens. At the end of the day, he adds, “Investors’ perceptions are shaped by their most recent experience.”

Although many clients have taken a more conservative stance by investing in balanced funds and products with guarantees, says Jordan Zinberg, vice president with Toronto-based Danville Kent Asset Management Inc.: “This is not necessarily the correct approach,” That is why, he says, some advisors are beginning to look for “a little more torque” in their clients’ portfolios and are “starting to use alternative asset classes.”

These advisors recognize the importance of asset allocation, says Zinberg, but they are devoting a portion of assets to “high-torque alternatives in order to get outperformance for their clients.”

Still, there are many advisors who adhere to the traditional principles of asset allocation. Says Lou D’Aversa, senior financial consultant in Toronto with Ottawa-based MD Management Ltd.: “If the rate of return required is higher, we move up the risk ladder by increasing equities exposure.”

But regardless of the asset-allocation strategy you take for your clients’ portfolios, here are some basic guidelines that you should follow.

> Assess Expectations. In addition to a client’s investment objectives, risk tolerance and time horizon, you should take into account personal circumstances such as tax situation, marital status and family commitments. Achieving your client’s expectations is “all about need and capacity for risk,” says D’Aversa. However, you should be aware that “clients’ understanding of their need for return is very different from their actual need for return.”

> Mix And Volatility. In theory, conservative clients may hold up to 80% in fixed-income and 20% in equities, while aggressive clients may hold a much greater proportion of equities.

The right combination of asset classes can help reduce market volatility; however, it does not provide a guarantee against losses because correlation of asset classes tends to increase during market volatility.

> One Size Does Not Fit All. “The asset mix might be different for people in similar situations,” says Sullivan. Thus, a cookie-cutter approach will not work. There are varying risk profiles within each asset class, depending on the structure of an investment vehicle and its underlying investments.

> Be Flexible. In recent years, says Sullivan: “Market conditions have not favoured a ‘by the book’ approach.” Typical “rule of thumb” approaches are outmoded.

Adds Zinberg: “[There has been] a big shift in the landscape — clients are increasingly open to the idea of highly specialized niche funds, which are smaller and nimbler.”

> Be Diligent. Make sure your clients understand and buy in to your strategy. Put checks and balances in place to monitor performance. Advises Sullivan: “Revisit portfolios once or twice a year.” IE