The concept of distributor’s alpha and what it means to investors

The concept of distributor’s alpha and what it means to investors

In investment circles, the concept of “alpha” is well known and discussed. It basically refers to outperformance of a fund relative to its underlying index and alpha is what fund managers are usually tracked on. There is a lot of data on this metric and lots of statistics on other metrics derived from this one as well. However, I would like to draw your attention to another alpha which is not very well known and hardly ever discussed, which is the distributors or advisor’s alpha. Let me explain!

As per a recent MorningStar report, investor returns in a particular fund are typically lower than the same fund’s returns by about 2.5–5% on an annualized basis. Take a moment to process that fact. Investors are getting significantly lower return from the fund that they are investing in, compared to what they should get by simply staying invested. This data holds true across time periods (3, 5, 10-year returns) and across fund categories (flexi-cap, large cap, multi-cap, etc.). It is even more pronounced in sectoral and thematic funds. So clearly there is something at a very fundamental level that is causing this.

The only explanation for this consistent pattern lies in investor behaviour. Investors do not achieve the returns that they should be getting simply because they are tempted to act in a manner that’s against their own interest. They end up buying when markets are on an upswing and panic and sell when markets are falling. As a result, they end up squandering their returns in the process. When they look at their portfolio over a period of time, it’s not what it ought to be. As market participants, we see this happening time and again. Greed and fear are real, and they show up in the markets regularly! Acting on your impulses in the heat of the moment, can eat up between a fifth to a tenth of your returns as an investor! Yet not many people realize this.

The question arises: Why do investors fail to maintain a long-term perspective? Some investors fall prey to chasing fads or attempting to time the market, strategies that seldom lead to sustained success. Others base their decisions solely on past performance, instead of analysing whether the drivers of performance in the past will also hold true in the future. The tendency to exit when the market experiences temporary downturns disrupt the potential for long-term gains.

Additionally, decisions based on casual conversations can lead to sub-optimal decisions. By understanding these pitfalls, investors can navigate the complexities of the market and cultivate a more disciplined approach.

Fidelity, a US-based asset manager, analysed its clients’ portfolios between 2003 and 2013 and found that the best-performing portfolios belonged to those who had not touched their investments. Coincidentally, many of these investors were deceased! Of course, it is easy to say that investors should be stoic and not act on their emotions and impulses. However, this is very difficult to practice. Having monk-like detachment is not easy for most of us. Investors are swayed by sentiment, narratives, trends and headlines! This is where a seasoned advisor can play a crucial role.

Advisors who have seen the market closely, have observed multiple cycles and understand what may be temporarily moving the market versus a long-term fundamental change and are very well positioned to help their investors navigate these choppy waters successfully. Sometimes all it takes is a simple conversation with a human being who with his/her experience tells the investor not to panic but continue to stay invested. Especially when there is a relationship that’s been built with the advisor and the knowledge that he/she has the investor’s best interests at heart. There is a beautiful line in the movie, The Karate Kid, where Jackie Chan says, “Being still and doing nothing are two completely different things”. The advisor who helps the investor “be still” creates an alpha for them compared to an average investor without such an advisor. Thus, the role of the distributor is not only to advise an investor on the next best investment, it’s also to help the investor stay invested or exit when the time is right. This is what I call the “distributor’s alpha”. In some cases, this can be even more than the alpha a fund manager can generate. While all the attention is on the fund manager’s alpha, the oft-neglected distributor alpha holds the real key to investor returns.

So, is this alpha not worth pursuing and ensuring for all our investors?

Ganesh Mohan is chief executive officer, Bajaj Finserv AMC

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Published: 26 Dec 2023, 11:14 PM IST

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