Maximizing Your Retirement: Understanding Corporate Alpha for Smart Fund Management

By: Christian Ramos, L.F.A

Licensed Financial Advisor and Solicitor for Investments and Insurance

Beyond Raw Returns: A Smarter Approach to Evaluating Your Investments

Advance Reading for Investment Fund Managers.

Are you getting ready to invest in a fund or establish a retirement fund for your company?

Hold on! There's more to consider than just the rate of return. Let's explore alpha in retirement funds.

Experiencing a positive return on your investment portfolio is satisfying. A green Profit and Loss (PnL) statement appears to be a clear victory. But is a positive return always a favorable one?

Imagine this scenario: You invested in a stock and achieved a 25% return. That seems impressive. However, what if a basic market index fund, such as one tracking the PSEi, yielded 50% during the same period? Suddenly, your 25% gain seems less remarkable. You assumed the risk of an individual stock but earned only half of what you could have with a less risky, broader market investment.

In the Philippines' expanding investment landscape, many investors concentrate solely on the final profit figure. This is a significant oversight. To genuinely assess success, you need to ask a more insightful question: "Am I being adequately compensated for the risk I'm taking?" Thankfully, there's a professional metric for this: Jensen’s Alpha.

2 The Missing Elements: Risk and Expectation

Figure 1: Performance of Different Beta Levels. We simulate the returns whether in an uptrend ordowntrend.

Pure returns can be misleading because they overlook two crucial factors:

1. The Market Benchmark: What could you have earned elsewhere? This is the opportunity cost illustrated in the example above.

2. Volatility (Risk): How much fluctuation did you endure for that return? Some investments are significantly more volatile than others.

We measure this specific risk using a metric called Beta (β). Consider Beta as a score for an investment’s volatility relative to the market. The market itself has a Beta of 1.0.

• A stock with a β >1 is more volatile than the market. It carries higher risk, so you should expect a higher

return.

• A stock with a β <1 is less volatile and regarded as safer than the market.

By integrating the market’s performance, risk-free alternatives (like government bonds), and your investment’s unique Beta, we can determine what its return should have been. This is known as the Expected Return, often calculated using the Capital Asset Pricing Model (CAPM).

The True Scorecard: Discovering Your Alpha

Figure 2: Illustrating Alpha with Variable Beta

This is where everything converges. Jensen’s Alpha represents the gap between an investment’s actual return and its expected return.

Alpha = Actual Return - Expected Return1

• Positive Alpha: Well done! Your investment exceeded expectations for its risk level, indicating a skillful selection.

• Negative Alpha: Your investment didn’t perform as well as anticipated. Even if you made a profit, the reward wasn’t commensurate with the risk taken.

Revisiting our example: Your investment yielded a 25% return. Assuming a low Beta of 0.8 (indicating less risk than the market), the expected return for the period was calculated at 41%. Your Alpha = 25% (Actual) - 41% (Expected) = -16%

The outcome is a negative alpha. Despite being "profitable," your investment underperformed by 16% on a risk-adjusted basis. This insight distinguishes amateur speculation from professional investing.

From Theory to Action: Collaborate with an Advisor

Grasping concepts like Jensen’s Alpha lays the groundwork for developing an effective investment strategy. It’s about ensuring each part of your portfolio justifies its risk and works diligently for you. Navigating this level of analysis can be intricate, which is where we come in. As your financial advisors, we delve deeper to construct a portfolio aimed at generating positive alpha. We assist you to:

• Accurately Analyze Performance: We evaluate your current holdings on a risk-adjusted basis to determine what drives growth and what lags.

• Optimize Your Portfolio: We design a diversified strategy that matches your risk tolerance and aims to outperform benchmarks over the long term.

• Make Disciplined Decisions: We offer the clarity and expertise needed to maintain focus on your goals, avoiding emotional decisions influenced by misleading figures.

1For simplicity, we assumed the expected return is expressed as a percentage, but it can be calculated using Rf + β(Rm− Rf ), where Rf is the risk-free rate from government bonds like treasury bills and Rm is the market return.

Start a discovery meeting with a Licensed Advisor for Investments

Your financial future is too significant to be assessed by a mere green number. If you’re ready to develop a smarter, more resilient investment strategy, let’s connect.

Schedule a complimentary consultation with us today. Let’s uncover the true performance of your portfolio and set a course for enduring financial success.

Christian Ramos, L.F.A, has fulfilled all the licensing requirements established by the SEC and the Philippine Insurance Commission for both individual and corporate sectors. As a graduating Electrondics Engineer student from the esteemed U.P. Diliman, he is currently completing his professional Finance Advisory and Soliciatation residency at SJ&P Wealth Advisory, where he provides comprehensive investment guidance expertise.

Schedule a consultation with Christian by emailing christian.ramos@sanjoseandpartners.com or click here to book an online meeting today.