A recent article on MarketWatch refers to the op-ed in The Wall Street Journal to make a point about the hidden cost of money management. While the op-ed promotes index-fund over actively-managed mutual fund investing, the article correctly states that even in the latter most investors overpay for financial advice which typically costs about 1% on top of the expense ratios of passive vehicles.

However, the article then makes a mistake that is common in the financial press: it tries to directly compare the returns of one sample mutual fund (Alger Capital Appreciation, ticker ALVOX) to that of a single index (S&P 500® represented by the Vanguard 500 Index Fund, ticker VFINX) to make a statement about fund performance.

According to Alpholio™ calculations, since early 2005 the annualized standard deviation of returns of these funds was as follows:

Fund Volatility
ALVOX 18.25%
VFINX 15.61%

As can be seen, the volatility of ALVOX was about 16.9% higher than that of VFINX in this analysis period.

In addition, Morningstar currently provides the following standard deviations and categories of these funds:

Fund 3-Year SD 5-Year SD 10-Year SD 15-Year SD Category
ALVOX 16.07 20.84 17.43 21.67 US OE Large Growth
VFINX 14.02 18.84 14.56 16.17 US OE Large Blend

Again, the volatility of ALVOX was anywhere from 10.6% to 34.0% higher than that of VFINX in the respective analysis periods, which is also supported by the different classification of these funds. Therefore, comparing ALVOX to VFINX is highly misleading.

Both the article and op-ed seem to justify management fees if the financial planner “adds value” by adjusting asset allocation, i.e. periodically modifies the weights of index vehicles in the portfolio. In Alpholio™’s view, this type of adjustment does not add any RealAlpha™ because it only changes the risk profile of the portfolio, as reflected by its RealBeta™. A reference portfolio of exchange-traded products (ETPs) calculated by Alpholio™ will simply catch up to any such changes to match the risk of the managed portfolio. For a detailed description of the Alpholio™ methodology, please refer to the FAQ.

Pin It