Question

Please summarize the article and how it applies to the real-world and Financial Management issue:

ARTICLE

Many investors strive to capture alpha—the excess return above an investment benchmark that can be earned by careful securities selection. But as families expand their wealth and their financial affairs become more complex, beating the market becomes a much smaller factor in the success of their overall wealth management plan.

Growing and preserving wealth across generations depends on applying the concept of alpha not just to investments, but also to all aspects of a broad wealth plan: tax minimization, estate planning, spending and borrowing.

“Investment performance is important, don’t get me wrong. But if I can save a client $14 million with an estate planning strategy, that’s going to have more impact than one individual investment manager outperforming their peers or the benchmark by 50 basis points,” says Ben McGloin, a managing director and Head of Advice, Planning and Fiduciary Services at BNY Mellon Wealth Management. “Alpha has historically focused on investment results, but the new alpha is a broader measure of success related to a range of financial planning disciplines.”

The new alpha mindset is proactive, involving a continual search for opportunities created by shifting market and economic conditions and changing family goals. It is far removed from the transactional, piecemeal type of services financial institutions traditionally provided. It also requires advisors to have deep and long-term relationships with clients, and to collaborate with their attorneys, accountants, trustees and even extended family members to make the most effective decisions.

“The critical elements to success are not only creating a customized wealth plan, but also making sure it is fully executed and then finding opportunities to move clients toward their goals more effectively,” McGloin says, adding that advisors and their teams must be prepared to pivot as circumstances change—and not just for the purpose of driving investment returns.

Consider the large daily stock market declines as concerns mounted about the COVID-19 virus’ global economic impact. As U.S. stock indexes fell, rather than simply enduring the volatility with white knuckles, there was plenty of work to be done by advisors in collaboration with clients’ accountants and estate planning attorneys to find ways to take advantage of lower stock prices. For example, significant benefits could be found in strategically realizing certain losses to use as capital gains offsets or in transferring ownership of battered stocks into a grantor retained annuity trust, which are optimal wealth transfer tools for investments poised to rise in value.

Quantifying alpha when the concept is applied across all facets of financial planning isn’t always a precise mathematical equation. With investments, alpha is simply defined by how much return you earn above your investment’s benchmark index. If a U.S. large-cap stock manager earned 35% last year while the S&P 500 had a total return (including the reinvestment of dividends) of 33.07%, the actively managed portfolio’s alpha was 193 basis points.

Measuring the success of a strategy to reduce future tax on the transfer of fine art to heirs or a savvy plan for the sale of a family business isn’t as clear-cut. But the value of planning that takes a wide view of someone’s complete financial life can be appreciated—if not perfectly summed up—by first setting personal goals, and then using sophisticated financial planning technology to analyze likely outcomes based on different planning moves.

For example, one family may set a “benchmark” involving savings earmarked for grandchildren’s undergraduate college education costs, with the idea that excess growth in these funds could be used to cover graduate school tuition. Another family may realize they’re overspending on advisory fees and set an annual savings benchmark on financial planning services of 1%, requiring a reorganization of assets.

“Broadly speaking, a common measure of success for clients is their ability to do what they want once they retire or seeing that they are achieving their goals in an efficient manner,” McGloin says. However, he adds that alpha is also produced by preventing clients from making unfortunate decisions based on emotions or tips from well-meaning friends or family members.

He once assisted a client who was eager to buy a new home and about to close a cash deal to prevent the seller from moving on to another buyer. “This would have meant pulling money out of the markets, which would have had big tax implications,” McGloin says. “Because we understood this client’s profile so well, we were able to act quickly to come up with a better solution—by securing a line of credit.”

While the ability to achieve broadly defined alpha depends largely on having an experienced, knowledgeable advisor, an important part of the equation is the willingness of a family to fully cooperate with their advisor. The more a family shares about its personal circumstances, the more effectively advisors can help. This can mean some short-term discomfort discussing family relationships, spending or other issues, McGloin says, but it enables an advisor to steer clients toward goals more effectively—and leads to better long-term outcomes.

Answer 1

First of all, trying to understand what Alpha means.

Alpha, often considered the active return on an investment, gauges the performance of an investment against a market index or benchmark that is considered to represent the market's movement as a whole. The excess return of an investment relative to the return of a benchmark index is the investment's alpha. Alpha is a good measure of performance that compares the realized return with the return that should have been earned for the amount of risk borne by the investor.

Every security has a required rate of return, as specified by the capital asset pricing model (CAPM). The CAPM equation is used to identify the required return of an investment; it is often used to evaluate realized performance for a diversified portfolio. Because it's assumed that the portfolio being evaluated is a diversified portfolio (meaning that the unsystematic risk has been eliminated), and because a diversified portfolio's main source of risk is market risk (or systematic risk), beta is an appropriate measure of that risk. Alpha is used to determine by how much the realized return of the portfolio varies from the required return, as determined by CAPM. The formula for alpha is expressed as follows:

α = Rp – [Rf + (Rm – Rf) β]

Where:
Rp = Realized return of portfolio
Rm = Market return
Rf = risk-free rate

A positive alpha indicates the portfolio manager performed better than was expected based on the risk the manager took with the fund as measured by the fund's beta. A negative alpha means that the manager actually did worse than he or she should have given the required return of the portfolio.

Pros of alpha

Alpha can give fund managers a general idea of how their portfolios are performing against the rest of the market. In trading and investing, alpha can be helpful tool for establishing market entry and exit points.

Cons of alpha

Using alpha as a method to calculate returns has its limitations – it cannot be used to compare different investment portfolios or asset types, as it is restricted to stock market investments.

Hence, to conclude, it is important to evaluate how efficient your portfolio is with the help and advice of your fund managers and to establish a healthy relationship with them for the achievement of your long term and short term financial goals.