Morningstar Advisor - December 2012/January 2013 - (Page 60)

Gray Matters Alpha, Beta, and Now … Gamma By David Blanchett and Paul D. Kaplan Measuring the importance of intelligent financialplanning decisions. The benefits from “good” financial-planning decisions are difficult to quantify. For any given portfolio, investment decisions generally can be decomposed into two primary components: beta and alpha. Beta can be defined as the systematic risk exposures of the portfolio (usually achieved through asset allocation), and alpha is the residual (skill or luck-based) component associated with the various flavors of active management, such as tactical asset allocation, security selection, and more. Alpha and beta are at the heart of traditional performance analysis; however, their impact on a successful retirement can be far less important than other financialplanning decisions. In this article, we introduce a concept called “Gamma,” which is designed to measure the additional expected retirement income achieved by an individual investor making intelligent financial-planning decisions. Gamma is the third letter in the Greek alphabet (preceded by alpha and beta), and within financial economics, it is sometimes used as the variable denoting an investor’s degree of risk aversion. Given that Gamma is relatively unclaimed within financial literature, we seek to give it new meaning. Gamma varies for different investors as well as for investors in different lifecycles (for example, the accumulation stage versus retirement). For those who find it hard to break from traditional (and inadequate) performance measurements, Gamma is a metric that is somewhat comparable to alpha, or excess return, but even more than that, it is the return that an investor 60 Morningstar Advisor December/January 2013

Table of Contents for the Digital Edition of Morningstar Advisor - December 2012/January 2013

Morningstar Advisor - December2012/January 2013
Letter From the Editor
What Stands Between Me and Stupid
Why Do You Use Dynamic Funds of Funds?
Serving Clients and Community
How to Pick an ETF Managed Portfolio Strategy
Tactical View of Risk
Investments á la Carte
Investment Briefs
Unbundling ETF Managed Portfolios
Risks Loom Over Telecom Industry
Outsourcing Asset Allocation
ETF Managed Portfolios on the Rise
Age-Based Options Take Over 529 Industry
How the Landscape for Advisors Is Changing
Mark Egan Embraces Volatility
Alpha, Beta, and Now … Gamma
Performance Gaps
Gains in Momentum
Companies Where Management Teams Add Value
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
The Once and Future King

Morningstar Advisor - December 2012/January 2013