Seeking advisor alpha – The Hindu

The best investment advisors can add value to your investment decisions. Research in this area has shown that the difference in returns between an advisor-managed portfolio and a self-managed portfolio, referred to as advisor alpha, can be significant. This doesn’t mean you should hire an investment advisor to manage your investments. Two factors are important in this context. First, an investment advisor may not add significant value if you decide to invest in passive funds. This is because your investments are most likely to be made through systematic investment plans (SIPs) for the time horizon for a life goal. The appropriate benchmark could be a large-cap index (NSE 100 Index) or a broad-cap index (NSE 500 Index). Choosing a benchmark index fund or ETF doesn’t require much expertise. Second, if you have the time and expertise, do you tend to manage your own investments? If not, it is best to seek out an investment advisor.

However, the outcome of an investment decision is determined by both skill and luck. This is because collective human behavior drives asset prices, determining whether your investments will generate positive or negative returns, or outperform a benchmark index. This means that advisor alpha is a function of both skill and luck.

Solution

When you hire an advisor, your goal is to generate consistent (advisor) alpha returns. The more consistent advisor alpha is, the more you can believe that the advisor’s skill, not luck, drives investment performance. More importantly, make sure you understand how your investment portfolio will likely be managed (recommended); It’s easy to blame an investment advisor when the performance of your investment portfolio doesn’t match your expectations. Also understand that your advisor can only determine your risk tolerance level (the level at which future losses, if any, would cause emotional and financial pain for you). Your loss tolerance will likely be lower when investment losses occur; that is, your actual pain threshold. Keep in mind that the difference between your risk tolerance and loss tolerance levels can have an impact on your asset allocation.

(The author offers training programs for individuals to manage their personal investments)