Measuring your Professional Alpha
February 5, 2013
Jim Cramer, Suze Orman and other so-called investment pundits and gurus are constantly telling consumers that they can do a great job of managing their portfolios on their own. Why pay a fee for professional asset management when you can turn on the TV and get Cramer's stock-picking expertise for free?
I've just learned that the Center for Financial Planning and Investment at California State University at Northridge is attempting to quantify the value of professional asset managers compared with nonprofessional do-it-yourselfers. As we wait 18 months for this paper to make its way into academic literature, let's look at what we already know.
Last week, Wade Pfau summarized research that suggested, among other things, that retirees who work with financial planners can get more mileage from their retirement portfolios – approximately 1.82% higher returns during retirement.
Let’s look at what the research has to say about the various investment performance benefits that advisors should be able to give their clients during the accumulation phase of their lives– excess returns above what do-it-yourself investors could obtain on their own. I call those excess returns "professional alpha."
The biggest source of professional alpha
Let's start with investor return vs. investment return. Whenever I give presentations or moderate panels on new investment concepts, I start by telling the advisors in the audience that they're taking for granted the most significant tangible value that many of them provide to their clients. By keeping your clients steadily invested and stopping them from chasing hot funds or asset classes and from selling out at the bottom of bear markets, you virtually guarantee that they will beat the only benchmark that really matters: the returns they (and their peers) would achieve on their own.
Do-it-yourselfers often make poor decisions, as during the Tech Wreck bubble. At the recent American Institute of Certified Public Accountants (AICPFA) Personal Financial Planning Conference in Las Vegas, Carl Richards of the Buckingham Family of Financial Services pointed out that prior to the year 2000, the record net inflow into equity mutual funds had been $29 billion. That record was broken in January of 2000 ($46 billion in net inflows), and again in February ($54 billion) and March ($39 billion).
The tech bubble burst in March, meaning all those dollars were buying into the market at the best time to sell.
In 2002, a new record was established: It was the first time ever that there were five consecutive monthly outflows from equity mutual funds. The last of those months was October, which saw the market low – meaning all those dollars were flowing out at the best time to buy equities in more than a decade.
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