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The adviser ‘alpha’ bet

Should you believe advisers who try and sell on claims of outperformance?

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Ian Millward
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In investment terms, ‘alpha’ measures how much an investment deviates from its benchmark index. So, for example, a fund that simply tracks the FTSE 100 should display little or no alpha whereas you would expect a more active fund to have a high alpha.

It is often seen as a measure of fund manager skill but, of course, alpha can also be negative reflecting that many managers typically fail to beat their index.

When building an investment portfolio, the odds very much favour playing the percentages and not trying to be too brave or clever. Warren Buffet has described investing as simple but not easy. It is a good description as investing can be simple if you have the discipline and fortitude to ignore the many conspiring forces that make it appear otherwise.

Investing is a test of nerve and character, and it is very easy, and understandable, to lose heart when markets fall or to be overly affected by recent performance (whether good, bad, or indifferent).

That is why many people choose to consult professionals. However, there is often a conflict of interest as the way to wealth for those that work in the industry is to encourage complexity and activity.

Our own approach owes little or nothing to claiming powers of ‘alpha’ and we focus on what we can control, namely diversification, carefully controlling costs and good communication. We certainly don’t claim exclusivity on running sensible portfolios but nor do we concede that there is a superior approach to our own.

The main reason so many active funds underperform is simply down to cost but, for most financial advisers, cost is the elephant in the room. Indeed, the biggest untold story of recent years has been sky -rocketing adviser charges.

Arguably we shouldn’t be too surprised. Commission was banned because understandably the regulator believed it affected adviser behaviour. Putting advisers in control without the requisite transparency was never likely to end well. For many clients, adviser costs now exceed fund manager costs and are the single biggest charge they pay.

When quizzed, financial advisers tend to stick doggedly to their ‘because I’m worth it’ line but, in reality, they are protected by opacity and the true impact not being laid bare. Excessive charges really are as simple as taking money that should be in your pocket and putting it in your adviser’s.

But as invidious and damaging as high charges are, I have a bigger bugbear today. That is the breed of local financial adviser who try and sell on claims of outperformance; the ‘alpha’ bet adviser. Thankfully these days, most firms have taken investment decisions away from individual advisers and, whilst this may result in excess cost, at least, the final portfolio is sound.

But there is a dying breed of advisers who like to play fund manager themselves. Sometimes it is because they genuinely think they can. As the saying goes, a little knowledge is a dangerous thing. But usually, it is because they know it is the easiest way to a sale. Showing portfolios populated with top performers is hard to resist and for advisers from a direct- sales, ’eat what you kill’ background, the ‘sale’ is all that matters.

Yes, it is almost bound to lead to disappointment, but, if the first year is disappointing, they act swiftly, replacing laggards with the new best seller. And so on. Given our natural predisposition to trust, it can take years to see through this by which time the damage is irrecoverable.

We try to be the antithesis of what people have generally come to expect from financial advisers. Yes, we prosper by taking on new clients, but we see that as a by-product of always trying to do the right thing. We often do a lot of work on a goodwill basis, we are open with information, keep fees low and only take on a client when it is in their interests. Despite having utmost faith in our portfolios, we would never dream of selling on claims of outperformance and our goal is simply to help people, not just clients, make better financial decisions.

The joys of running a business often means that the urgent takes precedence over the important but, as we grow, it allows us to lift our heads a little. We have recently produced a guide ‘Investing Made Simple’ and are currently putting the final touches on a tutorial video ‘Advice charges – the power of percentages to mislead.’

We will happily leave the ‘alpha’ bet to others. Our intention, in time, is to build an A to Z of suite of guides and tutorials aimed at debunking information and helping people find their way through the financial services maze.

You can download a copy of ‘Investing Made Simple’ here.

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