Alpha And The Quest To Beat The Market

TruePoint Capital

You hear the term “alpha” being constantly bandied by Wall Street, but what is alpha, and why is there always talk about chasing or achieving it?

In investment terms, alpha is a measure of the performance of an asset or investment strategy compared to the market. A positive alpha means an asset outperforms the market, while a negative alpha indicates underperformance.

​​For example, an alpha score of zero means an asset is tracking with market performance – typically measured by a market index like the S&P 500. An alpha score of 5.0 means an investment outperformed the market by 5%. In contrast, an alpha of -5.0 means an investment underperformed the market by 5.0%.

Matching market performance shouldn’t take any effort. You have to invest in an index fund to achieve market returns passively. The implication is that beating the market (aka achieving alpha) will take effort through active investing.

To garner investor interest, many hedge and mutual fund managers and financial advisors will tout their ability to beat the market through their active investing skills. They claim to achieve alpha – thereby consistently beating the market. However, theoretically, it isn’t easy to achieve alpha in an efficient market where the immediacy and widespread availability of information about a public stock or company nullify any distinct informational advantages an active investor may possess.

Data supports the efficient market neutralizer hypothesis.

​​According to a 2020 report, over 15 years, nearly 90% of actively managed investment funds failed to beat the market. Of the professionals who did manage to beat the market, many were unable to consistently year-to-year – mostly the recipients of one or two lucky streaks. The moral of the story? Achieving alpha by playing the stock market game is nearly impossible.

If achieving alpha is darned near impossible, how do the ultra-wealthy investors manage to beat the markets year after year consistently?

The answer? They play a different game in a different league.

We talked about the futility of information advantages in an efficient market, but how do successful investors get around this roadblock? They invest in alternative assets – assets found in the private markets that are not susceptible to the same factors or subject to the same rules as public assets.

If you play by Wall Street’s rules, chasing alpha is a game you can play but are unlikely to win. That’s because everyone else has the same information you have access to, and it’s because you can’t control the movement of your assets. No matter what you do, you will never be able to force the growth of an investment asset unilaterally.

Successful investors chase alpha away from Wall Street – gravitating towards alternative assets in the private markets where they can take advantage of informational advantages and opportunities to force appreciation. It’s why ultra-wealthy investors allocate major portions of their portfolios towards commercial real estate (CRE).

With CRE, information advantages such as local contacts and connections for finding off-market deals can still be leveraged to achieve above-market returns. In addition, CRE allows proactive investors to force appreciation through incremental improvements in income and reductions in expenses.

Want to beat the market? Want to achieve alpha?

Seek alternatives like CRE where management skills and expertise can be put to use to leverage information advantages, opportunities to force appreciation, and tax benefits to beat the market.