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 management, estate planning, spending, and borrowing.
“Investment performance is important. 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."
A New Mentality
The new alpha mentality 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 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 not just for the purposes 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. 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.
Resetting the 'Benchmark'
Quantifying alpha 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/ASX 300 was up 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 market, which would have had big tax implications," McGloin said. “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 the 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.