An investor's personal trainer
What value do you expect a financial adviser to add to your investment success?
If you expect an adviser to create an investment portfolio that will consistently outperform the markets, you are likely to face disappointment.
It is a reality that an adviser will almost inevitably struggle to add value for a client through market-timing and selection of securities - particularly after costs and taxes are taken into account. This mirrors the difficulty faced by the majority of actively-managed funds despite their experience and resources.
Fortunately, skilled financial advisers can potentially contribute significantly to their clients' investment long-term success in ways that have nothing to do with market-beating performance.
For the past 14 years, Vanguard's Investment Strategy Group in the US has studied what it terms "Adviser's Alpha". This is defined as the value that advisers can add through their wealth management and financial planning skills - guiding their clients in such areas as asset allocation, cost and tax efficiency, and portfolio rebalancing - and as behavioural coaches.
In other words, skilful advisers can add considerable value by using the best wealth-management practices together with personally encouraging their clients to adopt disciplined, long-term approaches to investing.
Vanguard just has released a new Australian edition of this classic investment research, using local data in an endeavour to quantify the direct value or "alpha" an adviser may add through such services.
The authors of the Australian report - including Francis Kinniry, a principal of Vanguard's Investment Strategy Group, conservatively estimate that "Adviser's Alpha" may add about three per cent, at least, to a client's net returns. Much, of course, will depend on an investor's circumstances.
For many investors, the best investment and wealth management strategies described in the report are likely to provide an annual benefit - such as from reducing investment costs and taxes. Nevertheless, the most significant value-adding opportunities would tend to occur intermittently and often during times of market duress or euphoria, according to the report.
During market duress or euphoria, advisers can act to urge their clients not to abandon carefully-prepared and appropriate long-term strategies in response to widespread market fear or greed.
Vanguard's report outlines six ways that adviser's can potentially add value that have no relationship to attempts to outperform any benchmarks:
- Asset allocation. As Smart Investing has discussed many times, research has long shown that asset allocation is the primary determinant of a portfolio's return viability and long-term performance. Advisers can guide clients on the creation of portfolios designed to maximise their potential returns within their personal tolerance to risk.
- Behavioural coaching. With a strong personal relationship with a client, an adviser is in an excellent position to encourage a disciplined, long-term approach to investing as opposed to getting caught up with the prevailing emotions and "noise" of the markets.
- Cost-effective investing. By encouraging clients to invest in low-cost managed funds such as traditional index funds and Exchange Traded Funds (ETFS), advisers can add considerable value. The report uses Australian data to support this point.
- Rebalancing. Through periodic rebalancing of a portfolio, an adviser can ensure that a client's asset allocation remains consistent with the risk/return characteristics of their target or long-term portfolio.
- Tax efficiency. Advisers can create strategies to ensure that their clients make the most of tax-advantaged savings opportunities over the long term from acquisition to disposal.
- Total-return versus income investing. Particularly at a time of historically low yields from balanced and fixed-income portfolios, advisers can explain to clients the benefits of focusing on their total returns from a diversified portfolio - that is income plus capital appreciation.
Advisers can alert clients to the added risks of moving away from well-thought-out investment plan in an effort to maintain their yields.
Significantly, this Adviser's Alpha research should reinforce the qualities that investors should look for when choosing a financial adviser as well as reinforcing the fundamentals of sound investment practice.
By Robin Bowerman
Smart Investing
Principal & Head of Retail, Vanguard Investments Australia
25 February 2015
