Key Factors in Adviser’s Alpha
Following on from the last post, where we looked at what an adviser’s alpha is, Neil Cowell of Vanguard talks more about why it’s helpful for clients to understand how it benefits them.
For an adviser, to be able to articulate and put a number on the value that they add to the client relationship is a big deal, especially since the Retail Distribution Review abolished commission on pension and investment advice in 2013.
Neil explained that ‘Alpha’ comes from the world of investment, and describes the extent to which a particular fund or fund manager outperforms their stated aim or benchmark – the extra value they add from being a fund manager.
The ‘adviser’s alpha’ suggests that advisers themselves can add alpha in the day in, day out services and practices that they deliver to their clients.
Not all advisers are created equal
It’s important to understand that advisers can add value, but not all do. Too many advisers are still transactional, that is, they are all about selling products to clients, rather than helping them achieve their long-term aims.
Vanguard’s research into adviser’s alpha identified seven key areas where the adviser adds value to the client relationship. Neil talked me through these in turn, to clearly explain what each area is and how it’s beneficial.
He clarified that they don’t see these as an exhaustive list, but they are aspects of the adviser-client relationship where evidence demonstrates an adviser can really add value.
1. Asset Allocation
Vanguard calls this the bedrock. Asset allocation the practice of understanding the client’s stated aims, their life goals and risk profiles, and then ensuring they have the right balance of equities and bonds in their portfolio to meet those aims.
We often see that clients left to their own devices just gather funds from various sources without paying as much attention as they should to risk profile or the movement the portfolio might experience over time. This is why we think asset allocation is the foundation of good investing. We often say to clients: “See your financial adviser as your risk manager, rather than your return-seeker.”
I’ve found with my own clients that people amass pensions, investments and funds over time and these are often not well diversified. People often have too many UK-centric funds, for instance. The UK only represents about 8% of the value of world stock markets, so arguably it makes sense to have more money outside the UK market than in it. And many people choose their funds as a result of marketing messages, either directly to the client or to the adviser by the fund house itself.
Asset allocation is about the spread of assets and the correct matching of an investment approach to the clients’ risk tolerance, timescale and goals. Vanguard believe this is the beacon to which every future conversation should come back to. What is the client trying to achieve, what’s the appropriate risk profile and are we on track to meet it?
If you’d like to know more about asset allocation, I’ve got a free cheat sheet you can download here. It gives you an idea of different risk profiles and timescales, and what different asset allocations might look like.
Rebalancing is the next step, and is related to Asset Allocation. If getting the allocation right initially is critical, then keeping that allocation right throughout the life of an investment is equally critical. Rebalancing is the discipline of ensuring that the chosen asset allocation remains in place and doesn’t drift, and is achieved by buying and selling assets periodically to reset the asset allocation to the desired split.
This is generally not something that clients do when left to their own devices, largely because it appears completely counter-intuitive. You sell well-performing assets and buy assets that are performing less well. But the practice is part of a good adviser's toolkit, and the evidence clearly demonstrates the benefit of rebalancing over time.
Over time, a portfolio will drift, and usually towards a heavier equity weighting. If that isn’t in line with your goals and risk tolerances, it can cause a lot of trouble.
Regular rebalancing, then, is a critical discipline and one of the areas where an adviser can add real value (alpha). After all, if an individual is looking after their own investments, they’re unlikely to sell their best-performing assets and buy the worst-performing ones.
I asked Neil if he thought there was an optimum frequency for rebalancing in his opinion, and he said that Vanguard’s studies pointed to a twice-yearly rebalancing schedule. More frequently than that means you may have to factor in the costs associated with rebalancing, so twice a year is plenty, and annual rebalancing is likely enough for most people.
In the next blog, we’ll continue the list of the main areas where advisers really provide value for their clients.