In the next few years, a client’s evalu- ation of their advisor will boil down to the professional’s ability to do twothings: add alpha and keep them invested.True, these have always been core components of an advisor’s role, but in the comingyears they will take on added significance.
Why? It’s a function of a low-returnenvironment, and the psychological roller coaster that is likely to unfold.
Let’s start with the low-return environment. There is good reason to believethat returns from both equities and fixedincome will be lower in the coming years.
Equities rebounded quickly from theinitial pandemic-induced sell-off. Loftystock valuations do not reflect the economic reality of the highest unemployment level since the Great Depression.High unemployment levels likely meana slow economic rebound, and lowerreturns from equity markets as earningsslowly recover.
Investors can probably count on lowreturns from fixed income as well, whichhistorically have been highly correlatedto yields. Today’s historically low yieldssuggest that future fixed income returnsmay not be as compelling as they havebeen in the past for investors.
If low returns persist, clients shouldperceive an advisor’s ability to sourceincremental alpha as a greater valueadd than they would in a higher returnenvironment.
Consider the math: If a passive, traditional stock and bond portfolio returns15%, for example, and an advisor’s allocation decisions lead to a 16% return for theclient, that 1% of extra return only adds
6.5% of total return (1%/15%). But in an
environment where market returns are
only 5%, for example, an extra 1% of extra
return makes up 20% of the total return.
Suddenly, that alpha means a great deal.
CHECKED EMOTIONS WILL
Keeping investors’ emotional and behavioral impulses in check also has been acritical advisor role. This too could takeon added importance. Admittedly, noone can accurately predict when volatility will ramp up. It’s the surprise element in markets that usually sparks it.
But there are plenty of events in thenext few months that set the stage forpotentially higher volatility includingeconomic uncertainty, fears about anongoing pandemic, geopolitical tensionsand an upcoming U.S. election.
If March’s selloff and subsequentrebound has taught us anything, it’s thatmarkets can react to bad news swiftly, and sharply, then recover almost asquickly. An investor who jumped to thesideline in early April would have donesevere damage to his or her portfolio.
Given the potential for more volatility
events, advisors will need to embrace
the role of client psychologist again, and
keep their clients invested. Clients will
appreciate it as rebounds follow.
ALTERNATIVE STRATEGIES ESSENTIAL
As advisors look for incremental alpha
and seek to keep clients invested, alterna-
tive strategies can help achieve both goals.
To improve the risk-adjusted returns
of a client’s portfolio, advisors either can
rely on active equity and fixed income
managers to produce alpha within their
respective asset classes, or seek alterna-
tive strategies that are less correlated to
traditional markets. The skill of active
managers has been spotty over the last
decade, which suggests advisors may
need to broaden their horizons to other
asset classes that include alternatives.
Many alternative strategies also can
dampen overall portfolio volatility,
and, in turn, play a role in keeping cli-
ents invested through the market cycle
because they don’t see their portfolio
fall as far. Until recently, it had been
quite some time since alternative strate-
gies were tested in a volatile market. But
March provided a microcosm of how
they can help portfolios — even just a
simple 50/50 allocation to long/short
equity and managed futures would have
allowed investors to realize roughly a
quarter of the market drawdown.
March’s performance is not surprising. Adding alpha and dampening drawdown have always been the hallmark ofalternative strategies. For advisors, theiruse has never been more critical.
Josh Vail, CAIA, is president of 361 Capital.
By Josh Vail
A Clear Path to Client Satisfaction:
Add Alpha, Stay Invested
Lower returns in equities and fixed income returns mean
advisors have to get creative.