Advisers use risk management to ride out market turbulence

SAN FRANCISCO — The stock market has remained unsettled since the big plunge of Feb. 27, but many financial advisers report few worries, attributing their well-being to the risk management inoculation they have given their client portfolios.
“[Clients are] happily surprised to hear they haven’t lost money,” said Russell Lundeberg, president of Barrett Capital Management LLC in Midlothian, Va. He founded the company in 2002 with the exclusive use of alternative investments as a differentiating factor for risk-sensitive clients.
Barrett Capital manages $115 million.
“It’s a beautiful time for us,” said P.J.
DiNuzzo, president of DiNuzzo Investment Advisors Inc. in Beaver, Pa., which manages $205 million. “People call and say, ‘How much are we down?’ and we say, ‘You’re in the black.’”
Mr. DiNuzzo said he makes use of more hedging strategies through Rydex Investments of Rockville, Md., and by buying assets uncorrelated to U.S. markets, such as a new international real estate fund from Santa Monica, Calif.-based Dimensional Fund Advisors Inc.
Indeed, the use of hedge funds, homespun hedging techniques and broader and more sophisticated diversification through international markets has gained a solid foothold among advisers.
For instance, Financial Information Group Inc. of Red Bank, N.J., recently polled advisers about their use of hedge funds. Of the 437 who responded, 150, or 34%, said they made allocations to hedge funds — which include funds of hedge funds — as of June 2006, up from 88 advisers in the same pool in 2005 and 45 advisers of the total in 2004.
But David Kelly, investment adviser for Putnam Investments in Boston, which manages $190 billion, thinks that advisers may be getting too hedge happy at just the wrong time.
“When the markets headed south at the turn of the century, advisers went into more exotic strategies,” he said. “Now some of the alternative investments have had their runs, and what looks cheap is just the plain-vanilla U.S. stock market.”
This view largely is shared by Andrew Rand, first vice president for Hoefer & Arnett Capital Management Inc. of San Francisco, which manages $2.5 billion.
“We think valuations are pretty attractive; we’re pretty bullish [about buying stocks right now],” he said.
But although stocks in the Standard & Poor’s 500 stock index seem modestly priced, there are reasons to be cautious — including slowing corporate profits exacerbated by declining productivity improvements, said Scott Brown, chief economist for Raymond James & Associates Inc. in St. Petersburg, Fla.
“All the technologies are embedded,” he said. “What’s next? I’m pretty sure it’s not Microsoft Vista.”
There are other reasons to favor good old-fashioned stocks over funds with hedging strategies, however, Mr. Brown said.
“Broadening diversity is fine, but a lot of people don’t understand what they’re buying when they delve into financial exotica, he said. “Hedge funds can do almost anything with their money.”

Fees are another reason to steer clear of products that Wall Street claims will provide steady 8% returns under almost any market conditions, said Neil Donahoe, principal and chief investment officer of SYM Financial Corp. in Warsaw, Ind., which manages $650 million.
“I got hit up on those [hedge-type products] after 2000” but passed on them in favor of index funds, which consistently have generated 15% returns or better the past few years, he said. “We cringe if we have to pay more than [.5%].”
The expenses associated with some alternatives “eat you up” in the long run, Mr. Rand added.
Staking out the middle ground, James Ferrare, senior vice president of Pinnacle Associates Ltd. of New York, which manages $4.8 billion, said it makes sense to use the best of conventional and exotic approaches.
“You can win two ways,” he said.
To hedge his mostly bullish bets on stocks, Mr. Ferrare is buying the UltraShort Mid-Cap exchange traded fund from Bethesda, Md.-based ProShare Advisors LLC because it generates returns inverse to the S&P MidCap 400 index. But he is buying large-capitalization stocks at the same time while shunning both emerging markets and real estate investment trusts, he said.
It makes the most sense to simply clear out of stock sectors that get pricey and overly popular, Mr. Donahoe said. Based on data from New York-based JPMorgan Chase & Co. showing that most flows into mutual funds last year were international, “we’re telling our clients to reduce their international allocation,” he said.
Recent events only reinforce fears of a growing bubble.
“What we saw when the Shanghai market went down nearly 10% in one day was a shot across the bow,” Mr. Donahoe said. “Momentum can get vicious on the downside, too.”
Any strategy requires a flexible approach, Mr. Brown said.
“Enjoy the party, but keep in mind where the exits are,” he said.