There’s a lot of talk these days about alpha and “smart alpha.” Alpha is basically return in excess of market performance. It’s a lot like happiness – everybody feels they deserve it, but it’s not been so clear where it comes from or how to get it. Fortunately, there’s evidence now about how to get alpha.
Vanguard, major ETF provider and a highly trusted voice in investing, tells us that your advisor can be a reliable and valuable source of alpha. What he or she does – and doesn’t do – can add significantly to the performance of your portfolio relative to the average investor’s portfolio. How much smart alpha can you get? About 3%, or 300 basis points, it turns out.
Vanguard did the research. Its analysts looked at the characteristics of higher performing portfolios versus average performers over 10 years, watching 50,000 individual accounts. What they found was seven areas that delivered excess return, totaling an average of about 300 basis points or three percent of potential added value over how investors are likely to manage their own accounts.
of Advisor Alpha
Value-add relative to
“average client” experience
|Suitable asset allocation||
> 0 bps
|Cost control (expense ratios)||
0 to 75 bps
|Spending strategy (withdrawal order)||
0 to 70 bps
|Total-return versus income investing||
> 0 bps
“About 3 percent”
We practiced smart alpha before it had a name
Regular readers will recognize these elements as the absolute cornerstones of our practice. We’re zealots for asset allocation, cost control, rebalancing, tax efficiency, and putting the right assets in taxable and tax-advantaged accounts. We’re obsessed with these fundamental strategies because we know they make a big difference, both individually and especially when working together.
And then there’s what Vanguard calls “behavioral coaching.” This element delivers by far the largest chunk of alpha. In this role we act as counselor, sounding board, voice of reason and dispenser of tough love to essentially protect investors from their own emotions, hunches and biases.
We help clients stay patient and disciplined, especially when markets are very bad or very good. We counsel against their natural but dangerous temptations to deviate from the long-term plan based on the latest news, pronouncements of market gurus and other short-term noise. Let’s face it, all the cost control and rebalancing in the world can’t overcome the cost of a panicky decision to bail out at a market low.
We’re delighted to see Vanguard’s objective quantification of advisors as a prime source of alpha; we couldn’t agree more. But it’s important to note that not just any advisor will do. Many advisors and brokers recommend expensive proprietary products, suggest “hot” stocks, try to time the market, ignore taxes, and make the same kind of bad recommendations investors could make on their own. I suppose that’s “remedial alpha” or “delusional alpha,” or something like that.
Where’s your alpha coming from?
– John F. Osbon – firstname.lastname@example.org
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