Key Messages
Rethinking Alpha: A Smarter Way To Achieve Investment Goals
The quest for alpha is a major focus of investors, as they strive to maximize returns and beat the markets.
But oftentimes, this so-called alpha does not actually deliver the desired results.
In his book ‘Better than Alpha’, the author reveals an alternative strategy – an intelligent approach to investing that defies conventional thinking and provides a better way to meet your investment outcomes.
The author explains that relying solely on intuition can lead to costly mistakes.
He then identifies one of Warren Buffett’s secrets – managing risk by using arbitrage.
He argues that successful investments depend on having the right strategies in place – strategies which aim at controlling risks while still producing positive returns.
This intelligent approach to investing emphasizes being proactive rather than reactive, understanding market dynamics and looking beyond traditional metrics when assessing risks and opportunities in order to make sound decisions.
Above all, it requires knowing how to take advantage of unexpected opportunities while avoiding costly mistakes and staying ahead of market conditions.
Alpha: Enticing Yet Unreliable And Easily Manipulated
Alpha has a reputation for being an alluring and elusive target for investors.
It’s defined as the excess return of an investment relative to the benchmark index, meaning that it’s a measure of how well an investor is beating the market.
It may seem like alpha gives you the edge you need in investing but unfortunately, it can be unreliable and easily manipulated.
Managers can manipulate alpha by choosing their own index or making their beta easy to beat, giving them false returns which they present as actual alpha.
This is why it’s so important to use efficient benchmarks when investing and to closely examine any potential alpha investments.
Alpha is also known to be unpredictable – its return can suddenly rise or fall and some funds which appeared successful have eventually dropped off just a few years later.
For large asset owners who control billions or trillions of dollars in capital, this unpredictability poses an additional challenge as it’s difficult for them to alter their allocations on such scale quickly.
Alpha Is Disappearing As True Alpha Becomes Harder To Find In An Overcrowded Market
It’s becoming increasingly harder to find true alpha in the investment world because of the recent boom in market factors and data.
True alpha is something that was created by selecting investments that differ from what the market is currently doing, and it’s a way to generate excess returns.
But due to the sheer amount of factors and data being generated, true alpha is quickly disappearing and being replaced by beta.
Studies have shown an accelerated decline in true alpha over time, as more and more market factors are created; these take away from what would otherwise be pure alpha, leaving nothing but beta—returns that rely on following the market.
This has also been compounded by the explosion of data available; experts estimate that each day brings about an amount of new data equal to 250 Libraries of Congress.
It’s no wonder Alpha can’t keep up with such a vast amount of information!
Given this situation, investors who want to remain successful must look for different ways to find or manufacture Alpha if they wish to improve their portfolio outcomes.
Doing so will require both technological solutions as well as human intelligence and creativity; it won’t be easy but it could bring great rewards if done right.
Don’T Rely On Inherent Heuristics Or Intuition: You Need To Put In The Hard Work To Beat The Market
We’re all wired to jump to conclusions quickly, but this can be dangerous when it comes to investing.
In many cases we’re prone to cognitive biases that lead us astray in our financial decisions, such as the inherence heuristic – this is where we automatically assume certain assets will perform well due to perceived inherent qualities.
That’s why it’s so important for us not to trust our intuition when making financial decisions.
As an example, let’s look at the illiquidity premium – historically, certain publicly traded assets have outperformed.
However, this doesn’t necessarily mean they are inherently better investments – there are likely external factors driving their positive returns such as dividend yield or low liquidity cost.
This is why Warren Buffett reads for up to eight hours a day – he knows that knowledge is power when it comes to making effective investment decisions.
If you want success, you need to keep learning too and gain an understanding of what really drives returns and performance.
Don’t be led astray by cognitive biases – and don’t rely on your primitive brain!
We Should Reserve Analytical Thinking For Major Decisions To Optimize Investment Outcomes
Slow, analytical thinking is critical when it comes to making important decisions that have a big, long-term impact.
This type of thinking is far more accurate than quick, intuitive thinking, but it’s also much more draining on our mental energy.
Our finite amount of mental energy needs to be carefully conserved.
Therefore, reserving System 2 thinking for only the biggest decision-making phases – like setting policies and selecting asset allocation in the investment process – is essential if you want your decisions to be informed and reliable.
The first step of policy setting should involve an extensive discussion regarding goals and how success should be measured, as well as an understanding risk and a timeline.
This requires research and careful deliberation in order to formulate the best policy.
Making sure to produce a comprehensive Investment Policy Statement can help with future decision-making.
Asset allocation should follow a similar methodical approach to ensure successful investment strategies.
By utilizing this slow and analytical thought process only for higher stakes decisions, you are guaranteeing each decision will be made with utmost accuracy while not overtaxing yourself mentally.
Using The 5P Framework To Improve Decision-Making During The Investment Process
When investing, it is essential to understand the due diligence process in order to make good decisions.
The 5P framework is the perfect tool to assist with this.
It includes performance, people, philosophy, process, and portfolio – all of which are integral for improving your investment results.
For manager selection, look at their past performance as well as key qualities such as intelligence and integrity.
Additionally, pick a team that works collaboratively with complementary skills and share values.
Make sure the process followed is consistent and thoughtful; look closely at the portfolio to monitor and manage risk through tactical asset allocation and rebalancing.
Research shows that you can get higher returns from careful due dilligence – one study uncovered that investors who do 40+ hours of due diligence succeed more often than those who don’t in angel investments on Fundify!
Utilizing the 5P framework during the due diligence process will put you on track for success.
Choose The Right Manager For Investment Success: Empower Experienced And Charismatic Leaders
For successful investments, it is essential to have a leader who is competent, experienced and charismatic.
A leader with these three qualities can motivate their team and make well-informed decisions based on their experience.
Research on investment governance structures reveals that the wrong manager or leader can lead to financial disaster; therefore, it is important to choose one with relevant experience and good judgement when making investments.
Donald Trump is an example of someone who possesses strong charisma as a leader; similarly, a professional investment manager should also be charismatic in order to influence and motivate those they work with.
Additionally, an experienced individual such as a person who has dealt with 2,000 hedge funds will be better equipped to make decisions than someone who only has seen a small number of them.
The ideal leader should have power, charisma, and expertise to help achieve successful investments.
When possible, place qualified individuals in hierarchical positions for optimal outcomes rather than just having them carry out orders without authority or input.
In this way you can reduce uncertainties surrounding decisions and boost your chances of investment success.
Let Go Of Alpha: Put Science And Strategy Into Practice For Better Investing Results
It seems that Alpha is an elusive and almost mythical concept when it comes to investing.
Despite all the promises, the truth is that Alpha always remained out of reach for most people in history.
So, giving up on Alpha and chasing after nonsensical goals might be a sensible decision.
However, there are still ways that one can increase their chances of success – even if it means saying goodbye to Alpha once and for all.
For starters, one should invest in getting indexes and factors at the lowest possible prices when dealing with public markets.
Similarly in private markets, shift your efforts towards small more nimble managers as they are more likely to offer better returns.
What’s more is make sure the manager you choose has the ability to teach you something new which could help increase your chances of success.
So if you’re looking for excess returns without having to chase after Alpha at every turn, using proven strategies is key in shifting the odds in your favor!
An example of this can be found in The State of Wisconsin Investment Boards who use smart governance strategies combined with knowledge supplied by an expert investor which helps them consistently outperform their benchmarks – even achieving alpha!
At the end of the day, what really matters is meeting objectives through any means necessary, including taking risks or operating with illiquidity.
Therefore now take up a scientific approach to investment – and keep an open mind – so as maximize your chances for successful investing!
Wrap Up
The final summary of Better than Alpha is that finding alpha has become increasingly difficult, so investors should know better and look beyond that.
They should focus on improving their decision making and developing a strong framework with effective governance.
This will lead to better returns in the long run—more so than pursuing alpha alone ever could.
As an actionable advice, aim to make your investment process more efficient and accurate by systemizing it.
Create checklists and automated steps to ensure that you are choosing the best managers available and mitigating potential future errors caused by impulsive decisions.
Following these practices would put you in a much better position for success than chasing after alpha.
