The financial service industry is shrinking – bankers, traders, and brokers are losing jobs en masse – but, remarkably, assets-under-management and fees for independent investment advisors have continued to grow steadily throughout the financial carnage of the past 5 years; as noted by the title of this article in last week’s Wall Street Journal – “It’s an RIA (Registered Investment Adviser) World, Everyone Else Just Lives in it”

Why are investors increasingly relying on investment advisors?

2011 was another dreadful year for actively managed funds (funds which seek to select individual winners and losers). Equity mutual funds had their worst year since 1997 relative to the Standard & Poor’s 500 Index, as record-high correlation and price swings made it harder for money managers to pick stocks according to Bloomberg.com. The 50-day correlation of S&P 500 stocks to gains or losses in the full index increased to a record 0.86 in October

What this means is that investors were better to put their money in broad index funds which track asset classes such as large-cap stocks, municipal bonds, or commodities. These asset classes soared and plummeted over the course of the year in tandem with the latest financial headlines, and with so much turmoil, most investors felt more comfortable going to bed at night knowing they were paying a professional to select and re-balance their portfolio of index funds.

But isn’t 1% still an awful lot to pay for asset allocation and a little hand-holding when markets are crashing?

 There is no question that experienced professional advice can be extraordinarily valuable for building a long-term financial plan and avoiding the behavioral finance pitfalls that plague the vast majority of individual investors. Most investors are likely to benefit from some form of outside financial assistance. But a fee based on 1% of your assets can add up to a staggering amount of your wealth over time (especially in today’s low-yield environment).

Asset allocation can be challenging (and those index funds aren’t going to pick themselves). But in 2012, with asset allocation models (ours and others) available on the internet, it is a very, very do-able task for the average investor to manage their own portfolio. Investors can accomplish much of the fund management services provided by investment advisors by following the set-up and re-balancing instructions from these web-based models and then making the suggested low-cost index fund trades through an online brokerage account or mutual fund company like Vanguard.  Investment Advisors can then be consulted on an hourly fee basis for periodic strategic planning and advice.  

Americans are zealously pursuing value in other areas of their lives from online coupons to do-it-yourself home repair.  So it is surprising how well the traditional Investment Adviser business and fee structure is holding up.

After suffering through wrenching volatility throughout 2011, investors in US Equities looking at their year-end statements find that the value of their portfolios were largely unchanged -- the S&P500 Index rose approximately 2% for the year.  Small-caps gained only 0.66% and the mid-cap index dropped -0.12%.  

These returns may not seem particularly rewarding given all the risk and volatility markets experienced. Surprisingly the US markets were relative winners in 2011 - global equity markets dropped almost 15% in 2011 and promising growth economies like India and Brazil saw their equity markets plummet by more than 20%.

An even bigger surprise in 2011 was the identity of the biggest winner among the 11 broad asset classes we track - TIPS (Treasury Inflation Protected Securities).   Who would have guessed that this conservative asset class - a hedge against inflation - would easily outperform riskier asset classes?  Especially given the largely benign inflation environment in 2011.

At the start of 2011 many advisers recommended moving away from bonds given the low returns and risk of rising interest rates. This would have likely proved a mistake for most investors given bond's relative strong performance among asset classes.

We expressed concern about emerging market allocations (in the context of asset allocation). We still have concerns about emerging market exposure, but we encourage investors to maintain their recommended allocation to emerging markets over the long-term. We also suggested conservative investors consider shortening the duration on their bond holdings - a move which would have reduced returns in 2011, but a move which we think remains prudent for 2012. TIPS low returns may seem even more absurd now, but TIPS remain an important component of our risk-controlled portfolios.

Volatility, as measured by VIX (CBOE's Volatility Index) dropped significantly in December, possibly signaling better equity market conditions ahead.  Volatility is one of the key drivers of Portfolio Research's allocation algorithm. This may be the light at end of the tunnel.  (Or it may be an approaching collision). Either way your best bet is a diversified portfolio.

December was a relatively quiet month for equity markets with the "Santa Claus Rally" failing to materialize amidst concerns about sovereign default in Europe.  The patterns we saw for all of calendar year 2011 -- Bonds out-performing Stocks,  US Large Caps out-performing smaller stocks, and international equity markets lagging badly -- continued for the month of December.