Advisors Alpha and Beta Management

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.