To understand alpha, one must first ask whether alpha exists at all. In my view, the concept only really matters if you start from the efficient market hypothesis.
One good example of where alpha can exist is long-term investing as a possible source of alpha, with emphasis on “possible.” As shown in that study, top-performing money managers who outperformed over the long term also experienced long periods of underperformance versus peers and benchmarks.
That might lead us to believe there is an edge in long-term investing, combined with the ability to remain confident in your investments even when they lag the index. This does not mean that funds with drawdowns will necessarily outperform, but rather that those who do outperform often have to endure meaningful drawdowns along the way.
Classic short-term pain for long-term gain. Seems like Nike’s slogan might be the key to outperformance.
This is just one piece of the puzzle. You could argue that those funds that outperformed may not have done so on a risk-adjusted basis, given how much they lagged the market at times. My response would be: how are we defining risk? Is it the possibility of permanent loss, or is it volatility?
You could argue that, in this example, there is no time/risk/reward-adjusted outperformance, and that might be true. But we could add further variables to the mix: illiquidity, forced selling, ESG-restricted buyers, and so on.
My objective is to find areas of the market where I can achieve high returns because of variables the market classifies as risks and therefore demands higher returns for, but that matter very little to me.
For example: I can buy illiquid companies, in industries ruled out by many funds by prospectus, with a 10-year time horizon.
I do think shorting levered ETFs is a form of alpha. Shorting anything has right tail risk, so I understand the compounding risk. But these products are essentially an expensive form of leverage that appeals to short term traders, retail investors who don’t / can’t use margin, and IRAs. You are being compensated - in my view, more 5an fairly - for providing that.
If you haven’t done so yet, try to find a copy of Ole Peters’s The Ergodicity Problem In Economics. Time decay (or vol drag) is not circumscribed to leveraged ETFs.
Hi Andrew,
I think you’ll enjoy this read:
https://content.rwbaird.com/RWB/Content/PDF/Insights/Whitepapers/Truth-About-Top-Performing-Money-Managers.pdf
To understand alpha, one must first ask whether alpha exists at all. In my view, the concept only really matters if you start from the efficient market hypothesis.
One good example of where alpha can exist is long-term investing as a possible source of alpha, with emphasis on “possible.” As shown in that study, top-performing money managers who outperformed over the long term also experienced long periods of underperformance versus peers and benchmarks.
That might lead us to believe there is an edge in long-term investing, combined with the ability to remain confident in your investments even when they lag the index. This does not mean that funds with drawdowns will necessarily outperform, but rather that those who do outperform often have to endure meaningful drawdowns along the way.
Classic short-term pain for long-term gain. Seems like Nike’s slogan might be the key to outperformance.
This is just one piece of the puzzle. You could argue that those funds that outperformed may not have done so on a risk-adjusted basis, given how much they lagged the market at times. My response would be: how are we defining risk? Is it the possibility of permanent loss, or is it volatility?
You could argue that, in this example, there is no time/risk/reward-adjusted outperformance, and that might be true. But we could add further variables to the mix: illiquidity, forced selling, ESG-restricted buyers, and so on.
My objective is to find areas of the market where I can achieve high returns because of variables the market classifies as risks and therefore demands higher returns for, but that matter very little to me.
For example: I can buy illiquid companies, in industries ruled out by many funds by prospectus, with a 10-year time horizon.
Open to discussing further.
I do think shorting levered ETFs is a form of alpha. Shorting anything has right tail risk, so I understand the compounding risk. But these products are essentially an expensive form of leverage that appeals to short term traders, retail investors who don’t / can’t use margin, and IRAs. You are being compensated - in my view, more 5an fairly - for providing that.
If you haven’t done so yet, try to find a copy of Ole Peters’s The Ergodicity Problem In Economics. Time decay (or vol drag) is not circumscribed to leveraged ETFs.