Vanguard: Advisors Can Add Alpha By Protecting You From The News Headlines

by Corey Philip
July 21, 2016

Vanguard has became the king (or maybe more of a saint) of passive index fund investment with a line up of low cost ETFS.  All the while Vanguard still has active management funds in place and doing quite well.   According to Vanguard, they believe it gives them a “a uniquely objective perspective on using active management to enhance relative returns.”

The paper gives much evidence to performance chasing of individual investors or in other words the tendency of investors to invest in/with firms, funds, or asset classes that have been doing well.  It then knocks that down by showing that :

the returns that investors receive may be very different from those of the funds they invest in,1 since cash flows tend to be attracted by, rather than precede, higher returns. On average, for the ten years ended December 31, 2015, fund investors trailed the funds they invested in by 86–229 basis points per year, according to Morningstar. The advisor’s alpha target, then, might be to improve upon

investor returns

Beyond individual investors, pension funds do the same thing.  Research shows that pension funds who hired managers with recent outperformance, tended to under perform the fired firms in the one, two, and three year periods.

Although return-chasing behavior is often associated with individual investors, evidence suggests that institutions do so as well. Goyal and Wahal (2008) looked at the hiring and firing decisions of a group of plan sponsors from 1996 through 2003. They found that the hired firms outperformed the fired firms in the periods immediately preceding the decision to change, but underperformed the fired firms for one, two, and three years thereafter (see Figure 5). that figure

So with individual (and pension fund) investors chasing returns that they likely aren’t going to get, what does vanguard say advisors can do to add Alpha?

  1. Determine asset allocation: nothing new there.
  2. Choose between active or passive funds.
  3. Manage Taxes

While the paper doesn’t outline this an actionable item, it makes a key statement:

They should act as wealth managers and behavioral coaches, providing discipline and experience to investors who need it. On their own, investors often lack both understanding and discipline, allowing themselves to be swayed by headlines and advertisements surrounding the “investment du jour”—thus often achieving wealth destruction rather than creation.

So there we have it.  Advisors should protect you, from the news headlines and bullshit of investment world.

About the author

Corey Philip

Corey Philip is a small business owner / investor with a focus on home service businesses.

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