According to Investopedia, “Alpha is often considered to represent the value that a portfolio manager adds to or subtracts from a fund’s return.” A positive alpha of 1.0 means the fund has outperformed its benchmark index by 1%. Correspondingly, a similar alpha would indicate an underperformance of 1%. It is inappropriate for an investor to rate the success or failure of an investment merely by looking at its returns. The more appropriate consideration is determining if the manager’s performance was sufficient to justify the risk taken for the return. There is a question that is appropriate here. The question is, do investment advisors add alpha? To see this material on YouTube kindly watch:
Sophisticated advisors construct portfolios by employing some form of asset allocation process to determine the most suitable portfolio for their clients’ particular goals. While some focus on traditional investments, others divide traditional asset classes into sub-asset groups, as still others add alternative investments; other than cash, bonds, and stocks. No matter the mix of investments, the objective is the same;to obtain the highest possible return for a given level of risk. Index funds and Exchange Traded Funds are often placed in allocations, but it may be that an advisor selects actively managed investments in the attempt to enhance performance, thereby validating the advisor’s fees.
Show me the money
For some investors, paying fees regardless of whether or not there are transactions may feel like “money for nothing.” First this may be looking at the advisor’s value proposition through only one part of the cost-benefit lens. The benefit and wisdom of not allowing near-term market actions to result in the abandonment of a well-thought-out investment strategy can be underappreciated in the moment. Second, many mutual fund investors rely on the prospectus to accurately reflect the cost of ownership. According to personalfund.com there is a huge miscalculation in this practice. This source reports that 70% of the expenses of owning a mutual fund are the transaction fees for the purchase and sell of the positions taken. Transaction fees are not reflected in the prospectus. The same source goes on to disclose that the average cost of a mutual fund is 2.40% a year, before the broker is compensated by any fee or commission. The bottom line here is that most investors do not see the whole enchilada. All things equal, we can all agree that lower costs are cheaper, if not better, than higher costs. But all things are not equal. More importantly, it is appropriate to have full transparency to recognize all of the costs, as it is sometimes, but not always the case that you have to pay more to get more. It is also true that some of the time, investors can pay the same or less and still have more.
Control what you can
While there are often places within a given portfolio to pursue outperformance, the essence of the advisor’s alpha concept is that the investor relationship be based on consistent market outperformance is unrealistic. To be successful the smartest way to invest is to see and review your goals, be aware of where to control and compare costs, be broadly diversified, and have a good plan and stick with it. The era of the transactional advisor is history. Investors no longer define their success by merely the growth of their portfolios. Today they view investing in terms of their life goals, such as college and financial independence, and they depend on trustworthy, attentive professionals who guide their path toward these goals and the maintenance of their goals. Astute advisors will refocus clients’ attention on the performance of their entire portfolios, beyond the performance of an individual investment or asset class. Clients deserve to be coached to evaluate progress toward their long-term goals, rather than concentrate on recent investment returns. When a particular asset is underperforming, it is important to show clients how other parts of the portfolio are contributing. Short-term volatility and negative returns can overshadow a positive long-term trend. Clients like to see the big picture and advisors can help them work through moments of emotional crisis and stay committed to their broader financial strategy.
Advisors add “about 3%”
At a recent conference in Denver, Brian Scott, CFA, Senior Investment Analyst, Vanguard Investment Strategy Group stated that Vanguard has attempted to quantify the potential value to investors’ net returns. Scott stated that for some clients’ advisors “may offer much more than 3 percentage points of increased returns on an annual basis over time. For other investors, less. The 3 percentage points come after taxes and fees. This return is not added over a specific time frame but varies each year and according to client circumstances. It can be added quickly and dramatically, especially during periods of market decline or euphoria. It may be added slowly. It will not appear on a client’s quarterly statement but it is real nonetheless.” Vanguard goes on to remind us that providing services such as estate and succession planning, or offering advice on long-term care insurance, residential real estate options, and charitable giving, have value as well, even if they are not quantifiable. One thing is for sure. The difference between a goal and a wish is a plan.
John L. GraceThe opinions voiced in this article are for general information only. They are not intended to provide specific advice or recommendations for any individual and do not constitute an endorsement by NPC. To determine which investments may be appropriate for you, consult with your financial professional. Please remember that investment decision should be based on an individual’s goals, time horizon, and tolerance for risk. Investment in stocks will fluctuate with changes in market conditions and indices are unmanaged measures of market conditions it is not possible to invest directly into an index. Past performance does not guarantee future results. Diversification helps you spread risk throughout your portfolio, so investments that do poorly may be balanced by others that do relatively better. Neither diversification nor rebalancing can ensure a profit or protect against a loss. Securities and advisory services offered through National Planning Corporation (NPC), Member FINRA/SIPC, a Registered Investment Adviser. Investors Advantage and NPC are separate and unrelated companies.