By Neil Cowell, head of Retail Sales, Vanguard Asset Management
It is an easy temptation for investment professionals to measure the success of their support for clients exclusively in terms of performance. It boils down to a simple set of numbers that can be explained in ways that seem to make sense.
It is also, in our view, wrong. Investment success does have a performance element, of course, but it should be measured relative to meeting an investor’s goals rather than against market benchmarks. Those goals are set in the future, while in the short-term the market can be a noisy, distracting, sometimes frightening place. It is not always obvious that a portfolio is on track or that opportunity is being fully captured.
As investment professionals, we know from hard experience that good advice is often most valuable at the most hazardous moments. But rather than telling clients that advice is valuable, how can we show it? And better still, how can we show it in quantitative terms?
Vanguard has researched that question over several years, drawing on extensive experience in the US, Canada and Australia as well as in the UK. The focus has been on breaking down financial advice into core components and then as far as possible identifying clear, quantitative values for each component.
Overall, the research shows that the value of investment advice, which we have called Adviser’s Alpha[i], averages out at roughly 3% a year. It is a significant sum when compounded over a longer-term investment horizon.
The research team identified seven key areas in which wealth managers add value. Asset allocation is probably the most important value add. It typically accounts for the lion’s share of returns and calls for a coherent, goals-oriented portfolio. But it is all too easy for a less experienced investor to “collect” funds based on the most recent performance tables, fund launches or advertising campaigns. Such investors don’t always fully appreciate the relationship between risk and return, and end up being either too cautious or taking on too much risk.
Asset allocation may be the most important component but, in our view, it is impossible to quantify due to the idiosyncratic needs of each individual portfolio. Broadly quantifiable value-add can be identified for areas such as behavioural coaching, cost-effective implementation and regular portfolio rebalancing.
Let’s take behavioural coaching as an example. As we touched on above, it is at times of fear and euphoria that good advice is most needed, when clients need to be guided through market extremes. Academic research suggests behavioural coaching can add 100 to 200 basis points a year to portfolio returns. These figures are broadly corroborated if we compare retail fund flows with market performance. Looking at the 10 years to 31 December 2013, across a broad spectrum of popular UK asset classes, it is a fair estimate that the average sterling investor underperformed fund returns by 0.5—2%. The only exceptions were emerging market and North American equities, where the average investor saw marginal outperformance[ii]. This shows the extent to which reactive portfolio changes can adversely affect returns.
The investment industry in the UK is in the midst of a period of great change. If we are to make the best of the opportunities change brings, we need to understand the value of what we’re doing and be ready and able to communicate it effectively. The Vanguard research is designed to provide a framework for this communication.
[i] Adviser’s Alpha: Putting a value on your value, Vanguard Asset Management, November 2014
[ii] Difference between investor and fund returns, as defined by the asset-weighted average in each categore. Vanguard calculations, based on data from Morningstar Inc