Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 131

The biggest rort of all

As a beginner investor there are a myriad of asset classes you can invest in and it must be a bit confusing knowing where to start. So let me give you an idiot’s guide to rating investments from ‘alpha’ to ‘beta’. Stick with me.

Alpha is an expression from the funds management world used to describe the ‘excess return’ of an investment relative to a benchmark. In the industry it is used as an expression to denote how much value someone is adding to your investment returns above the average. If funds management was a gladiatorial sport the fans would be chanting “Alpha, Alpha, Alpha, Alpha!”.

Beta on the other hand represents how an investment performs relative to the market. All you need to know here is that a beta of 1 means an investment will move with the market and a low beta investment is something that moves less than the market. A beta of minus one, just to make it clear, is an investment that moves in exactly the opposite direction of the market and a beta of 2 is an investment that moves twice as much as the market when the market moves in a particular direction.

I like to think that alpha means ‘Action’ and beta is ‘Boring’.

With that little definition in mind let’s now look at the most common investments and rate them from high alpha, a lot of action, to low beta, no brain required. The first couple might surprise you but they should be on your list:

Building a business – This is a very high alpha investment, high activity, high risk but it is where all really wealthy people made their money, in business.

Your career – This is also massive alpha. Getting up, going to work, coming home for half your life. It is also, rather amazingly for a high alpha investment, about the lowest risk investment you can make. In terms of risk and reward, investing in yourself is one of the best investments in the whole world.

Then we come to traditional investments that are high alpha. These include:

Direct investment in equities and property - I have put these on a par because if you manage your own property investment or equity investment they are both hard work for similar returns. Both are very involved and both require a skill set. Both are high alpha, high activity with significant risk. They only suit you if you can service the need for action, not pretend to. This also makes the point that when weighing up which asset class is the best the answer is the one you will enjoy the most, know the most about, are more suited to managing, because both are very different activities meaning it is not really which asset class is the best, its which asset class you want to expend your alpha on.

Then comes a big drop in alpha to the first of the higher beta investments. These include managed funds and listed investment companies. It also includes the large super and industry balanced funds. These are investments that are marketed as if the managers are ‘adding alpha’ but really, the majority of them are benchmarked to an index and the moment you benchmark a professional, even if they consider themselves an ‘alpha adding’ fund manager, they unavoidably start to ‘hug the benchmark’ trying to emulate the benchmark which makes it a lot harder for them to beat it. Their investments will also become diversified across a lot of individual investments and because of that diversification these funds will never set your hair on fire despite the marketing and despite the fees. Some funds like smaller companies funds, sector funds and special situations funds may be more volatile and appear alpha orientated but even they have their benchmarks and their alpha compared to those benchmarks is more of a beta in the end even if it is more exciting.

Beta investments are things like index funds and passively managed exchange traded funds. Investments that do what they say they’ll do on the box, mechanically match an index, a market, a sector. They can be volatile, as volatile as the market they represent, but no-one is working them, they just represent an average, nothing else. And low fees.

Finally there are lower beta investments. These are investments that offer no value above the expected return. They are predictable, low risk and don’t require you to sweat them to get a return. They can’t be pushed. They include everything that offers no growth including hybrids, cash, term deposits and money under the mattress. I know a lot of people become highly concerned about the returns on these investments, but really, the main point is that you are taking very little if any risk and you are parking your money out of harm’s way instead of driving your money. The returns used to be enough to live on but they’re not anymore, pushing low risk investors into more risky investments.

The most common mistakes on this rating system are taking on a high alpha role yourself but not giving it the attention it requires and the second is the biggest rort in the investment industry, paying an alpha style fee when it’s obvious from the structure you’re only ever going to get a beta style return.

 

Marcus Padley is a stockbroker and founder of the Marcus Today share market newsletter. He has been advising institutional clients and a private client base for over 32 years. This article is for general education purposes only and does not address the personal circumstances of any individual.


 

Leave a Comment:

     

RELATED ARTICLES

Competing for alpha

Is good IPO access worth the costs involved?

Smart beta: watch the details

banner

Most viewed in recent weeks

Stop treating the family home as a retirement sacred cow

The way home ownership relates to retirement income is rated a 'D', as in Distortion, Decumulation and Denial. For many, their home is their largest asset but it's least likely to be used for retirement income.

Welcome to Firstlinks Edition 433 with weekend update

There’s this story about a group of US Air Force generals in World War II who try to figure out ways to protect fighter bombers (and their crew) by examining the location of bullet holes on returning planes. Mapping the location of these holes, the generals quickly come to the conclusion that the areas with the most holes should be prioritised for additional armour.

  • 11 November 2021

Welcome to Firstlinks Edition 431 with weekend update

House prices have risen at the fastest pace for 33 years, but what actually happened in 1988, and why is 2021 different? Here's a clue: the stockmarket crashed 50% between September and November 1987. Looking ahead, where did house prices head in the following years, 1989 to 1991?

  • 28 October 2021

Why has Australia slipped down the global super ranks?

Australia appears to be slipping from the pantheon of global superstar pension systems, with a recent report placing us sixth. A review of an earlier report, which had Australia in bronze position, points to some reasons why, and what might need to happen to regain our former glory.

How to help people with retirement spending decisions

Super funds will soon be required to offer retirement income strategies for members in decumulation. With uncertain returns, uncertain timelines, and different goals, it's possibly “the hardest, nastiest problem in finance".

Tips when taking large withdrawals from super

You want to take a lump sum from your super, but what's the best way? Should it come from you or your spouse, or the pension or accumulation account. There is a welcome flexibility to select the best outcome.

Latest Updates

Interviews

John Woods on diversification using asset allocation

All fund managers now claim to take ESG factors into account, but a multi-asset ethical fund will look quite different from a mainstream fund. Faced with low fixed income returns, alternatives have a bigger role.

SMSF strategies

Don't believe the SMSF statistics on investment allocation

The ATO's data on SMSF asset allocation is as much as 27 months out-of-date and categories such as cash and global investments are reported incorrectly. We should question the motives of some who quote the numbers.

Investment strategies

Highlights of reader tips for young investors

In this second part on the reader responses with advice to younger people, we have selected a dozen highlights, but there are so many quality contributions that a full list of comments is also attached.

Investment strategies

Four climate themes offer investors the next big thing

Climate-related companies will experience exponential growth driven by consumer demand and government action. Investors who identify the right companies will benefit from four themes which will last decades.

Investment strategies

Inflation remains transitory due to strong long-term trends

There is momentum to stop calling inflation 'transitory' but this overlooks deep-seated trends. A longer-term view will see companies like ARB, Reece, Macquarie Telecom and CSL more valuable in a decade.

Infrastructure

Infrastructure and the road to recovery

Infrastructure assets experienced varying fortunes during the pandemic, from less travel at airports to strong activity in communications. On the road to recovery, what role does infrastructure play in a portfolio?

Economy

The three prices that everyone should worry about

Among the myriad of numbers that bombard us every day, three prices matter greatly to the world economy. Recent changes in these prices help to understand the potential for a global recovery and interest rates.

Shares

Why green hydrogen is central to achieving net zero

Hundreds of green hydrogen projects show this energy opportunity is finally being taken seriously. While a cost disadvantage and technical challenges need to be overcome, it promises to deliver a path to net zero.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.