Investment gurus managing Yale University’s $20.8 billion endowment recently touted in the institution’s annual report that, in terms of generating market-beating returns for the university’s portfolio – “alpha is not dead.” In a Bloomburg Businessweek article dated Feb. 27, 2014, Yale officials reported a 12.5 percent return on investments ending June 2013, beating the 11.3 percent average for foundations and endowments. These results seem to fly in the face of post-Great Recession investment advice that focuses more on mitigating risk and concentrates on obtaining smaller, sustainable investment returns.

The excess return when a mutual fund outperforms its price risk above its benchmark index is known as alpha. Yale officials conceded that their success is atypical, stating, “While alpha is not dead, opportunities to access it may not be available to all investors.”

It’s a statement Gil Baumgarten, president of Segment Wealth Management LLC based in Houston, Texas, not only agrees with but subscribes to, in approaching the management of his client’s investments.

It’s not that Baumgarten is against generating alpha. When investments he has chosen perform in an alpha mode, he’s pleased. He just isn’t seeking it outright.

“I think alpha-seeking generates fees,” Baumgarten said. “There is no correlation of the fees being charged in pursuit of alpha and the returns that could be achieved by simply relying on beta. All the fees that a client might have paid to a hedge fund for some exotic money manager in the hope of the pursuit of alpha almost always lead to disappointing returns and the certainty of much higher fees.”

Baumgarten is a beta investor relying on index products, exchange-traded funds and Vanguard funds with lower entry costs. He said he would rather buy into a vanguard product for six basis points versus paying 25 times that amount to a Fidelity manager or 100 times that amount to a hedge fund manager.

“The only person who generates alpha is the one who is consistently smarter than everybody else – or he is just lucky. If he is lucky, that is not repeatable,” Baumgarten said. “I think money managers for the most part add lots of risk to a portfolio and hope they are right. When they are periodically right, they claim how smart they are when really all they did is take more risk.”
Having open discussions regarding risk with clients and then accurately determining their tolerance for risk is a big part of Baumgarten's approach to customizing portfolios. Many clients cannot accurately gauge their personal risk tolerance without input from an adviser, Baumgarten believes. He views an adviser’s best service to a client as being the ability to contextualize the client’s true appetite for risk.

“That adviser who is doing a good job is the one who can artfully determine where a client’s risk and reward and expectation levels are disjointed from what that client is communicating, and then can guide that client into committing to something that can be deemed as a plan – and then create an investment portfolio that fits that plan,” Baumgarten said.

Learn more about Segment Wealth Management LLC online at www.segmentwm.com