Fittingly for an industry that likes to make everything far more complicated than it needs to be, investment professionals tend to refer to two of the most basic capital market concepts by the first two letters of the Ancient Greek alphabet; alpha and beta.
For the uninitiated, alpha is a measure of an investment’s performance compared to a benchmark — the FTSE 250, say, or the S&P 500. Beta, on the other hand, is a measure of the volatility of a particular security in comparison to the market as a whole — in other words, the tendency of its returns to respond to swings in the market.
Many of those who work in the investing industry are driven by the pursuit of alpha, or trying to beat the market. The media is also obsessed with the need to “outperform”, hence the plethora of articles about “undervalued” sectors or individual stocks that are due for a rebound.
As every evidence-based investor knows, alpha is extremely hard to find. Those who claim to know where to look for it exact a high price for their “expertise”, and yet, for whatever reason, the vast majority of professional money managers will fail to find it and take your money anyway.
Most investors shouldn’t be looking for alpha at all. They should settle instead for beta. In other words, they should accept market risk as the price to pay for market returns, and simply aim to capture the returns of entire asset classes as cheaply and efficiently as possible.
Thankfully, investing is changing. More and more investors, particularly in the US and increasingly in Europe and Australasia too, are starting to realise that seeking alpha is counter-productive. They’re giving up on stock-picking, market timing and active fund managers, and opting instead to buy and hold diversified portfolios of low-cost, passively managed funds.
Sadly, though, many advisers remain hooked on alpha. They won’t accept the mathematical fact that, after costs, the average passive investor must outperform the average active investor. There are several reasons why. For some, it’s force of habit, for others it’s professional pride. Others simply find alpha an easier sell. Sadly, in some countries, advisers and brokers are still financially incentivised to recommend products that aren’t in the client’s best interests.
Advisers would do themselves and their clients a big favour by giving up on seeking alpha in all the usual places. Alpha isn’t to be found in picking stocks or sectors, in “playing” Brexit, trying to spot the next Google or Apple, or timing the next market crash. It’s time for advisers to realise that they are the alpha — they are what enables an ordinary investor to end up as one of the winners.
Research published in 2014 by Vanguard concluded that good advice can add around 3% in net returns per year to a client’s portfolio. Compounded over time, 3% a year will make a huge difference, quite apart from all the peace of mind that having a trusted adviser provides. As value propositions go, that sounds pretty good to me.
If you’ve not yet seen it, you might be interested in The Value of Advice — a five-part video series we ran last week on the different ways in which an adviser adds value: asset allocation, cost control, portfolio maintenance and behavioural coaching.
You might also want to have a look at this video that my colleagues and I have just produced for Vanguard in the UK about its Adviser’s Alpha programme.