Advisor’s Alpha

One of the great debates around the investing world revolves around the extent (if any) to which advisors add value.  Many in the media say the number is either small or negative. Many advisor cheerleaders say the number is substantial.  Everyone should be skeptical.  What follows is my unscientific assessment of the pseudo-debate (two opposing factions that have a story to spin where it is difficult to ascertain or refute either position).

The people at Vanguard have long been touting their own research (complete with quantified bandwidths for varying activities) on this topic.  Their general position is that advisors add about 3% in “value” to their clients’ portfolios.  Colour me skeptical.  To begin, it is possible to drown in a river that is, on average, only two feet deep.  Averages can be deceptive, especially when the variance in the things being measured is likely to be wide.  There is really no such thing as an average advisor or an average client.  Using the word “typical” might be a bit more accurate and helpful, but frankly, I doubt it.

There are some good advisors out there – and some lousy ones, too.  When I hear people talk about the suite of services that might be offered, the usual presumption is that all advisors are doing all those things.  That’s simply not true.  In short, almost any assessment of value added (say 3%) is likely to be truest only of the very best practitioners.  Only the very best are likely to be doing all the good things that cause advisors to score highly.  Ordinary advisors don’t do those things.  Poor advisors might very well be doing the opposite.

That’s my major beef, but there are others.  Remember that advisors are not monolithic.  They’re all over the place regarding what they do, how they do it and who they do it for.  Part of that is because their clients are all over the place, too.  Some are slothful to the point of it being difficult to get them to do anything; others are hyper-sensitive to media hype and short termism.  Good advisors provide focus and discipline, but that is difficult to reliably quantify and, at any rate, likely looks different for different clients.

Two counter-narratives

Allow me to offer two counter-narratives to the idea of (most?) advisors (consistently?) adding 3% over a long-term time horizon.  The first is the annual Dalbar study, the “Quantitative Analysis of Investor Behaviour” (QAIB).  Dalbar admits that while the study purportedly shows how investors can do unnecessary harm to their return by (among other things) chasing past performance, the people at Dalbar have no way of disaggregating causation. 

To wit: are we measuring the harm done by investor behaviour or by advisor behaviour?  Most investors work with an advisor, so when the results are bad, it’s rather unfair to ascribe blame to investors exclusively.  Basically, the story is that many investors shoot themselves in the foot and would almost certainly do better if they worked with an advisor …. even though many of the people in the dataset are working with an advisor already!  The advisor might even be the source of the problem.

The second is the measuring of a default that could be very different depending on one’s view of choice architecture.  Vanguard says an advisor could add about 1% by substituting high-cost products out and putting cheaper products in to replace them.  I agree with both the sentiment and the quantification; but not the framing.  If the default position was using the lower-cost products in the first place, then the advisor’s value-add would be 0%, but there would be a value subtracted that amounts to about 1% if more expensive products were used instead.  In short, advisors should not be lauded for using cheap products: they should be pilloried for using expensive ones.  These are two sides of the same coin, but the narrative associated with the frame of reference changes the dynamics of the discussion considerably.  The bottom line is that there are all kinds of advisors out there.  My view is that the good ones are very good indeed.  My view is also that the bad ones are worse than useless… they likely diminish your returns when you work with them.  You need to be able to tell the difference between the good ones and the bad ones.