In the investment world, Alpha is widely perceived to be the Holy Grail.
But is this true for every investor?
I mean, it makes sense if you’re a hedge fund or giant money manager…
But not for individual investors!
You can read my full FT article on this topic here: Why beta outperforms alpha for retail investors
What follows is a highlight reel with added director commentary…
Spoiler alert: It’s far easier for individual investors to beat the S&P 500 than ‘the industry’ would have you believe.
I’ll explain:
What is alpha anyway?
Alpha, the act of generating risk-adjusted returns above a benchmark index, is how many investors measure success.
Achieving it consistently is the dream. But for even the biggest investors in the City and on Wall Street, alpha is a dream that too often descends into nightmare.
85% of fund managers fail to outperform the S&P 500 over a 15 year period.
Think about that.
With every possible resource at their disposal and billions to deploy, most professional fund managers can’t generate that sweet, mythical alpha…
So how could an individual investor possibly do a better job?
By playing a different game entirely!
Don’t outsmart Wall Street, outmanoeuvre it
Instead of chasing an unattainable goal, everyday retail traders and investors should focus on leveraging the advantages unique to their position. Rather than try to outsmart Wall Street, we should be outmanoeuvring it with agility and a playbook that is within our reach.
Agility is a HUGE advantage for smaller investors.
Unlike the giants, we can get in and out of the market (usually in a matter of seconds) without impacting market prices.
Because of their size, it can take large funds DAYS to execute that same trade!
This flexibility allows us to capitalise on trends that institutional investors will struggle to exploit due to these scale constraints.
The ability to ride trends & rotate through sectors, pivoting rapidly, and invisibly, is our best way of generating sustained returns, without the need to rely on alpha.
Levered beta > alpha
You do not need a billion dollars, a team of eggheads and an office on Lombard or Wall Street to put beta to work.
Now, beta is often misunderstood even though it’s a very simple concept.
Beta essentially quantifies how much an asset’s price moves relative to the market as a whole.
- Beta of 1.0 means the price of the asset essentially moves in line with the market
- Beta of less than 1.0 means the asset is less volatile than the market
- Beta of more than 1.0 means the asset or investment in question is more volatile than the market
Simple enough, right?
You might ask how anyone could misunderstand something so straightforward…
Here’s the typical smooth-brained thought process:
- Beta is Volatility
- Volatility = Risk
- Risk is bad
- Therefore Beta is bad
That third point is the crucial one…
Any notion that risk is inherently ‘bad’ is frankly, idiotic.
Risk is ever-present. The future cannot be known. Anything could happen at any time. That’s risk.
Yet somehow we learnt to tolerate it.
Throughout our lives we’ll do all kinds of risky things like starting businesses, changing jobs, having kids…
People voluntarily travel at INSANE speeds in steel cubes & tubes & think nothing of it.
So, yes. I cringe when people say that risk is simply bad.
Especially when those same people have never considered the risk of NOT taking risks…
The opportunity cost there is enormous, and massively under-appreciated
Obviously there’s a risk balance.
A sweet spot.
Nobody should rush out and simply buy the most volatile stock they can find.
But one principle always holds true…
There’s no reward without risk
The trick is finding the right kind of risk for the goals we’re trying to achieve.
Nobody should take risks they aren’t comfortable with.
Which is where risk-managed leveraged beta comes in.
Let’s break beta down to brass tacks. While chasing alpha might mean thousands of hours of research – scouring company filings, building models, hunting for a 3 per cent edge if you are lucky – risk-managed leveraged beta may require just a matter of hours to spot a trend, set up a trade and aim for a 15 per cent return with a 5 per cent downside floor.
The effort-to-reward ratio is not even close. Stick to strict rules and it is a playbook you can run again and again, not a crapshoot that hinges on being the smartest person in the room.
The keys to this approach? Discipline & clarity.
Discipline = Sticking rigidly to risk management rules to ensure losses don’t snowball.
Clarity = Knowing what you’re looking for & confidently striking when the conditions are right.
Our edge is not in outsmarting Wall Street’s brightest minds; it is in outmanoeuvring them with an agility and simplicity they simply cannot replicate. Retail investors win not by being the smartest, but by being the nimblest.
Stay nimble.