Advisor Alpha – How financial advisors can truly add value

He said he could do his own asset allocation, identify funds to invest in based on the information and ratings available, monitor his portfolio and transact easily across digital platforms. So, why should he go through the trouble of finding a good advisor? He could not see any clear value-addition that the advisor could provide and had not consulted one for several years.

I had to admit that the points my friend made were quite valid. Currently, there are any number of calculators and tools available online to help you assess your risk tolerance, set goals and calculate the SIP amount and tenure that can help you potentially achieve those goals.

Data on most funds is also readily available on several digital platforms, along with their performance records, assets under management, and star ratings. Furthermore, the ease of transacting has improved significantly in recent years. The clear implication is that if an advisor today is only helping investors with these things, their days are numbered.

With that in mind, I tried to clearly articulate the value of a good advisor. It also helped that I was a consultant in a previous life who got paid for his advice. As is the case in most of these things, I started with data.

I asked my friend the all-important question: “Are you happy with the returns in your mutual fund investments?”

He hemmed and hawed a bit and then somewhat shamefacedly admitted that he was not happy. Over the past few years, his portfolio had significantly underperformed the Nifty 50, an index of the top 50 stocks.

I asked him if I could look at his portfolio and transactions to see why that was the case. He readily agreed and the outcome of my analysis provided some interesting insights.

Returns gap

My friend had invested in good funds, but his returns were lower than what these funds had delivered in that period. The gap was not small – it was 3-5% on an annualised basis.

What could explain this? It turned out my friend had been getting in and out of the funds at the wrong times. At times, when the market fell and after reading headlines such as “ ₹5 lakh crore of investor wealth wiped out,” my friend redeemed his investments and locked in a lower NAV (net asset value) at exit.

He paused his SIPs in some cases, not taking advantage of the opportunity to buy more units at lower NAVs. He had also invested most of his money when the markets were close to their peaks and when valuations were elevated and there was a buying frenzy.

This behaviour is not unique to my friend. According to Morningstar, there is a systematic gap of 2.5-5% of annual returns between what the fund generates and what the investor gets. This gap exists for all types of funds across time horizons.

This gap in returns is the value that an advisor must target to deliver for their investors. I call this gap the “Advisor Alpha.” For this, advisors must ensure that investors carry out a proper asset allocation and stay invested, even through the inevitable difficult periods in the market.

They should advise them even more proactively when the markets are choppy to make sure that their behaviour does not become an enemy of their returns. In a memorable line from the movie, The Karate Kid, Jackie Chan says: “Staying still and doing nothing are two very different things.” This adage holds true in the markets as well.

In the mutual fund sector, the focus has always been on the alpha delivered by the fund manager. And while the fund manager’s actions are certainly important, of equal if not more importance is the behaviour of the investor herself.

What ultimately matters to the investor is the return made by her, which is where advisors can truly add value. In other words, the true role of the financial advisor is to manage the behaviour of the investor to ensure that they derive full value from the products they are investing in.

Those who deliver “Advisor Alpha” will never be redundant because human behaviour does not change.

I turned to my friend and said, “Well, now you know what you need to do.”

He smiled and said, “Not many people have been able to manage my behaviour, but I am willing to give a good advisor a try.”

Ganesh Mohan is CEO of Bajaj Finserv Asset Management Ltd