Graphs

IFA Client Study - Maximizing Your Return Relative to a Benchmark

Graphs

In seminal research dating back to 2001, Vanguard has been studying what it refers to as Advisor's Alpha.

The index mutual funds pioneer coined such a term to help explain a premium its analysts have discovered for investors who've worked with fiduciary-minded wealth managers in guiding their investment portfolios. This ongoing series has estimated that such advisors helped to produce an additional annual return value for their clients of around 3% -- including 1.5% for behavioral coaching and 0.26% for disciplined rebalancing. 

Of course, such an analysis is broad in nature and applies to thousands of advisors across the country. So, we thought it might be interesting to quantify portfolio results for clients of Index Fund Advisors with a definable track record.  

It's a research exercise that we've done in the past. In this study, IFA analyzed the performance of 533 clients1 who had been working with one of our advisors for at least 10 years from 2008 through 2018. This period included the decline of equities during the global financial crisis of 2008 and early 2009, as well as the subsequent recovery period.

How did we accumulate and disseminate such data? For each of the 100 benchmark IFA Index Portfolios, our portfolio management and research team maintains monthly historical returns that can be used to benchmark clients' time-weighted returns. In terms of individual portfolios, we determined annualized returns and compared such data to the annualized return of the originally recommended IFA Index Portfolio.

Even though many of these clients had inception dates prior to Jan. 1, 2008, we chose this time period so that each investor would have experienced the same market conditions. The clients were divided into three groups based on how closely they followed IFA's advice:

Group #1 - This group consisted of 209 client portfolios that did not decrease stock index allocations by more than 9% or increase it by more than 9% compared to IFA's original recommendation. We consider this group to be clients that followed IFA's advice. These clients captured 22.4% more of the available benchmark index portfolio return than clients in Group #3 who did not follow IFA's advice and substantially changed their risk level during the period.2, 3

Group #2 - This group consisted of 163 client portfolios that decreased stock index allocations by 10% to 25% compared to IFA's original recommendation. We consider this group to be clients that mostly failed to rebalance their portfolios and instead elected to recalibrate, or reduce the risk level of their original portfolios in response to the global financial crisis. These clients still captured 4.4% more of the available benchmark portfolio return than clients who substantially changed their risk level in Group #3.

Group #3 – This group consisted of 161 client portfolios that either decreased their stock index allocation by more than 25% or increased it by at least 10% compared to IFA's original recommended portfolio. We consider this group to be clients that did not follow IFA's advice.4

The results of the study are illustrated in this chart:

There are millions of investors who did not have the benefit of IFA's advice and we would estimate that they had even lower returns than those in Group #3 of our study. Unfortunately, we have not seen any comparable studies of actual client accounts during this highly volatile time period. In addition, we are not aware of any other firm that could even do such a study because it is unlikely they would have kept accurate records of 100 benchmark index portfolios, all the clients who invested in those same portfolios and the original recommendations for each client.

Again, this exercise is largely possible as a result of IFA's use of index-based funds, which provide a level of consistency in portfolio design and performance benchmarking that helps us to better evaluate how each individual client is doing over time in meeting their longer-term financial goals. 

To summarize, IFA has provided a real and measurable value to our clients who followed our advice and stayed in their index portfolio that matched their risk capacity, which was initially determined with their IFA wealth advisor. The clients in Group #3 paid a substantial returns penalty during this period, with that group of clients giving up about 22% of the return of their original index portfolio. That can be compared to the 0.32% above the IFA benchmark Index Portfolio return by clients in Group #1 who followed IFA's advice.5

The results of this study are clear. If you want to capture the returns that the global stock and bond markets have to offer, stick to a disciplined investment strategy that is based on decades of risk and return index portfolio data, an evidence-driven investment selection process and years of development of refined passive trading techniques.


Footnotes:

  • 1 - The 533 client portfolios consisted of those that were active for the entire period from 1/1/2008 to 12/31/2018, were not custom portfolios or special allocations such as sustainable or socially responsible, and had at least $100,000 by the end of the period. Portfolios using tax-managed funds were included.
  • 2 - Updated methodology from the previous client study ended in 2014: Reclassified 54 Clients from "Followed IFA's Advice" to "Did Not Follow IFA's Advice." Although these clients' starting and ending portfolios displayed the same characteristics as portfolios that followed IFA's advice, they did not follow IFA's advice because they changed portfolios ( /- 10 portfolios) within the time range of the study, adjusting risk down and up and vice versa. Thus reclassifying these portfolios provided a more accurate representation of which clients actually followed IFA's advice throughout the entire time period of the study and which clients did not follow IFA's advice.
  • 3 - Group #1 and Group #2 would still include exceptions to following IFA's advice such as failing to invest cash when available, transferring in non-IFA-advised securities and not immediately selling them, or not agreeing to rebalance when IFA recommended it. The impact of these deviations varied over time and clients.
  • 4 - Group #3 would still include clients that may have had legitimate reasons to drastically change their risk and thus actually were following IFA's advice.
  • 5 - It is important to understand that there are many reasons why a client's time-weighted return may be different than the return shown for the corresponding IFA Index Portfolio.
    • The Benchmark IFA Index Portfolio returns are calculated on a monthly basis and interpolated for mid-month returns, so a portfolio that starts in the middle of the month usually has a different return for that month.
    • The funds used to implement client portfolios vary with client situations and may be different than the funds included at the end of the time-series construction for the IFA Index Portfolios. For example, taxable accounts would have tax-managed funds, which may have different returns than the non-tax-managed funds used in the IFA Index Portfolios.
    • Actual client rebalancing will differ from the January 1st assumption incorporated into the IFA Index Portfolios. This could have made an especially large difference for portfolios that were not rebalanced near 1/1/2009.
    • Client returns are net of transaction costs while the IFA Index Portfolios do not include them.
    • Client returns are affected by allocations to cash for fees and withdrawals and client behaviors such as not authorizing the investment of cash immediately when it is deposited or asking IFA to raise cash and then not removing it from the account. They can also be affected by client preferences such as not reinvesting dividends.
    • The IFA Index Portfolio returns are based on a 0.9% advisory fee, and with a tiered fee schedule, clients with larger accounts have lower fees. The benchmark IFA Index Portfolio returns assume that the fee is taken on a monthly basis, but for clients, fees are paid on a quarterly basis. The returns shown throughout the IFA website and the benchmark portfolio returns shown on client performance reports are net of a 0.9% advisory fee, which is the highest fee paid by any IFA client. The IFA fee schedule includes a declining percentage fee for larger assets under management, so those clients with larger assets benefited even more relative to the IFA benchmarks.
    • Other factors that may have affected clients' returns for portfolios that include taxable accounts are the use of asset location, tax-loss harvesting, and the use of tax-managed funds.

This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product or service. There are no guarantee investment strategies will be successful.  Investing involves risks, including possible loss of principal. Performance results for actual clients that invested in accordance with the IFA Index Portfolio Models will vary from the backtested performance due to the use of funds for implementation that differs from those in the index data, market conditions, investments cash flows, mutual fund allocations, changing index allocations over time, frequency and precision of rebalancing, not following IFA's advice, retention of previously held securities, tax-loss harvesting and glide path strategies, cash balances, lower advisory fees, varying custodian fees, and/or the timing of fee deductions. Tax liabilities will vary per investor and can result from various activities in taxable and tax-deferred accounts. These activities include, but are not limited to a rebalancing of portfolios, any sale of securities, tax-loss harvesting, interest, dividends, and capital gains distributions from equity funds and individual securities in taxable accounts. Please see www.ifabt.com for more details on the construction and historical data of IFA Index Portfolios.