Home Articles VIEWPOINT: Alpha, beta … and gamma

VIEWPOINT: Alpha, beta … and gamma

Most of us are familiar that when it comes to investments, the essential elements are “alpha” and “beta”. Yet what about your “gamma”, otherwise called ”the value of financial advice”?

Simply, alpha is the added value that active investment management brings on top of beta, which is simply what the market achieves. The active versus passive management argument still rages long and hard, though the recent growth of index tracking or exchange traded funds (ETFs) suggests there’s a growing realisation that not all asset managers can consistently outperform markets. Some argue it’s not for a lack of skills, but rather their underlying fee structures which chip away at performance.

Fees are coming under increasing scrutiny in the debate on risk versus returns (before and after tax) on investments, in particular the level of fees (or commissions) paid to financial advisers. Interested parties include not just clients: regulators worldwide have championed the rights of consumers to fair and transparent fees paid for professional advice.

Vanguard Funds’ research team defines “gamma” as a more pragmatic version of “alpha” than just beating market returns, one “more aptly demonstrated by the [adviser’s] ability to effectively and simultaneously act as a wealth manager, financial planner, and behavioural coach, providing discipline and reasoning to clients who are too often undisciplined and emotional”.

Reinforcing this, researchers at Morningstar say that “a financial adviser has a greater probability of adding value, or alpha, through relationship-oriented services such as providing cogent wealth management and financial planning strategies, discipline, and guidance, rather than by trying to outperform the market”.

Morningstar suggest that advisers should rather focus on a few fundamental financial planning decisions/techniques for clients: a total wealth framework to determine their optimal asset allocation; a dynamic withdrawal strategy, incorporating guaranteed income products/annuities; tax-efficient solutions; and liability-relative asset allocation optimisation taking into account factors such as funding risks, inflation and currency.

Morningstar estimate a retiree can expect to generate 29 per cent more income on a “utility-adjusted” basis, equivalent to an annual arithmetic return increase of +1,82 per cent (that is, gamma-equivalent alpha) which “can be achieved by anyone following an efficient financial planning strategy”.

Of course, I’m not certain how many financial advisers will be crunching the numbers to quite this level of sophistication, or whether the regulators would even expect them to do so. However, what I am sure of is that “What’s my gamma?” is a fair question and one which I would suggest deserves a fair answer.


Author: Mike Lledo CA(SA) is the CEO at Consolidated Financial Planning