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.
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.
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.
This piece made me think about what it actually means to have edge as a long term investor. Sometimes having a perfect model is not the epitome of good investing. The Apple example proves that, someone just observed that the phone was better and held conviction for 15 years. Simple thesis, extraordinary outcome.
But if it can go right it can also go wrong. And I think that's where we are with AI right now. Everyone can see that AI is transformative, that observation is obvious. But we have no idea which player will be the last one standing, and that's exactly where the obvious thesis breaks down. The iPhone had one dominant winner relatively quickly. AI might not.
What I'd actually love to know is the flip side of the Apple story, a company where someone bought on an equally obvious thesis, held the same conviction, and it just didn't work out. Because without that example it's hard to know whether the Apple trade was genuine edge or just a great n=1
Hope the guy from consulting held Apple! I also hope for “obvious” since I don’t have the time to verify esoteric. Alphabet in 2025 seemed obvious because I remembered the smartest people in my Computer Science classes wanted to work for Google and not Microsoft. At the time Microsoft had double the multiple of Alphabet and I thought that was silly.
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.
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.
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.
Visa was the most obvious trade for me.
When I started investing as an 18 year old piker back in 2007, two trends were clear to me:
1) the decline of cash
2) the increase in online shopping. I assumed Visa was going to do well.
My only regret is I didn't buy more.
This piece made me think about what it actually means to have edge as a long term investor. Sometimes having a perfect model is not the epitome of good investing. The Apple example proves that, someone just observed that the phone was better and held conviction for 15 years. Simple thesis, extraordinary outcome.
But if it can go right it can also go wrong. And I think that's where we are with AI right now. Everyone can see that AI is transformative, that observation is obvious. But we have no idea which player will be the last one standing, and that's exactly where the obvious thesis breaks down. The iPhone had one dominant winner relatively quickly. AI might not.
What I'd actually love to know is the flip side of the Apple story, a company where someone bought on an equally obvious thesis, held the same conviction, and it just didn't work out. Because without that example it's hard to know whether the Apple trade was genuine edge or just a great n=1
You can use the magic formula to outperform so there’s that.
Hope the guy from consulting held Apple! I also hope for “obvious” since I don’t have the time to verify esoteric. Alphabet in 2025 seemed obvious because I remembered the smartest people in my Computer Science classes wanted to work for Google and not Microsoft. At the time Microsoft had double the multiple of Alphabet and I thought that was silly.
Could probably generate alpha longing and shorting T-Rex in the right moments. Or t-bills if you have a deep understanding of the credit markets.