When
we invest we look at alpha and beta. Simply put, how much more is the fund’s return
over normal benchmark and how well has the market risk been managed? Everyone
wants a minimum return and alpha gives an indication of return above the minimum
realistic expectation. All investment carries some risk and if one goes for
more return i.e. through equity fund route, he has to counter the market risk and
so beta gives us the measure of how the fund is placed vis.-a-vis. market risk.
Tracking of beta not only gives an idea of riskiness of an equity fund but also
how well the market risk is being managed.
Let’s
use the two terms in an advisor context in a clients investment advice. An
advisor who just helps to invest and get an above inflation return or a normal return
is providing a positive alpha but is he good enough? A good advisor is one who understands
all forms of risks well and helps his clients to manage that risk at the same
time.
In
reality the understanding of investment risk for a common investor is strikingly
different from the text book definition of investment risk. The understanding
of investment risk for a common man is loss or something that has probability
of loss, whereas, investment risk actually means deviation of realised return from
the expected return. This could be on the positive or on the negative side. Movement
on either side creates new expectation in the mind of common investor. Unrealistic
expectation of return or unnecessary fear of loss is also a form of risk which
an advisor has to manage.
An
advisor is supposed to do risk profiling and recommending as per clients risk
bearing and risk taking ability. How can he judge risk bearing ability accurately?
Three years back if an advisor said to anyone that you will get 15 % return in
equity fund he would have been very happy but if he says the same statement
today will his client be having same happiness? Now he has experienced over 50%
return so his expectation might be different now.
Now
if the expectation of a common investor grows due to his good experience in the
recent past so now an advisor has to tackle a new range of risk i.e. new
unrealistic expectation. For the client may be there is no risk ahead i.e. no visualisation
of loss but the advisor knows well that if the recent deviation has been abnormally
much more on positive side then in short term future the risk has increased i.e.
there could be correction in market and stock prices. The more the positive
deviation from normal return, the more is the risk on the expectation side. So
now how can an advisor correctly judge the risk bearing capacity or risk
tolerance level of an individual? Here the advisor with better beta management
comes into play i.e. how well he convinces and normalizes his expectation.
An
advisor’s risk management ability lies in is his advisory approach and
communication- how well he evaluates all types of risks that are directly or
indirectly associated with his client. Client can sometimes overlook his own
financial status, fall into greed or fear stage. Is an advisor bold enough to
differ with his client’s view or for the sake of appeasing the client agrees to
what he is saying and not cautioning him with logical explanation? It’s now the
advisor’s job again to not do something which can hurt client financially if
things go wrong. Impact of notional and real return on clients mindset needs to
be properly understood and ways and means to manage it with perfection is the advisor’s
beta management talent.
He
should be one who is cleaver enough to take the best of opportunities provided
but at the same time protect the growth. He should be the one whose intent in
long term is capital appreciation but capital preservation at every new stage
is equally important.
The
investment return growth path he should visualize for his client is not up and
down but it could be the stair-case approach i.e. there is a vertical growth but
that growth is preserved also. In other words, growth is vertical intent and
preservation are horizontal intent at each successive level.
