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June 13, 2013 at 11:26 AM
Possibly the most valuable content at the Morningstar Investment Conference is a rather technical session on the subject of “gamma” whose applications have immediate take-home value for financial advisors.
Morningstar’s David Blanchett delivered the talk. He, along with his Morningstar colleague Paul Kaplan, is the mastermind of gamma, a nifty Greek letter that comes after alpha and beta in the Greek alphabet but, as it does alphabetically, goes beyond those two in terms of adding value.
While alpha investors are looking to add that 100 basis points in total return and beta investors are seeking to match the market while minimizing risk, Blanchett and Kaplan estimate that gamma enables advisors to enhance the welfare of their clients to the tune of 29% more income, which equates to 1.82% in added alpha.
Better still, alpha is a zero-sum game—your win as a buyer is another investor’s loss as a seller. With gamma, however, every advisor and every client can win.
In practical terms, financial advisors often face a skeptical public that questions whether they are worth the fees they charge. If clients perceive that the key value the advisor adds is fund selection, many will cut out the middleman and buy the funds themselves, using consumer ratings.
What Blanchett and Kaplan have attempted to do is quantify all the ways an advisor adds value.
In a Thursday session at Morningstar’s Chicago conference, Blanchett divided an advisor’s value into five key areas: total wealth allocation; dynamic withdrawal strategy; annuity allocation; tax-efficient asset location; and retirement portfolio construction.
Tax-efficient asset location may provide the simplest example of a service advisors provide that increases client wealth.
Do-it-yourself investors may make excellent investment selections, theoretically, but limit the benefits of those investments by leaving “tax alpha” on the table.
A classic example is bonds. Because their realized income is taxed at ordinary income rates, they are highly inefficient from a tax standpoint.
Stocks, on the other hand, are far more tax-efficient, incurring a 15% capital gains rate.
