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Blink 3 of 8 - The 5 AM Club
by Robin Sharma
Listen to the Intro
Better than Alpha summary
Christopher Schelling
Three Steps to Capturing Excess Returns in a Changing World
24 mins
Table of Contents
Better than Alpha
Summary of 7 key ideas
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Key idea 1 of 7
Alpha is enticing – but it's also unreliable and easily manipulated.
Alpha. If there’s one thing you share with your fellow investors, it’s probably a fascination with this alluring and elusive target. But, just like a beautiful mirage, alpha seems to disappear on closer inspection.
Before we examine this mystery in more detail, let’s take a moment to define alpha – a term that’s often misused. Alpha is the excess return of an investment relative to the benchmark index. In other words, alpha is basically a measurement of how well an investor is beating the market. By contrast, beta is the index return that’s achieved through passive ownership of securities in a specific market.
As an investor, you want alpha – not beta. However, that’s easier said than done.
The key message here is: Alpha is enticing – but it's also unreliable and easily manipulated.
Managers can easily distort alpha to suit their own ends. By picking their own index and choosing an easy-to-beat beta, they can present excess returns as alpha. But, as the saying goes, all that glitters is not gold. Close analysis often reveals that this so-called alpha is actually beta. This is why it’s so important for managers to use effective benchmarks before making the investment.
Alpha is frustratingly random and unreliable. It comes and goes. This trend is apparent in public markets, private equity, and hedge funds. The latter originally appeared to be an alpha success story, with hedge fund superstars like Warren Buffett and Barton Biggs making breathtaking returns.
But the data shows that since 2005, hedge fund alpha has been in decline. The author gives the example of one hedge fund that boasted historical returns of “100% pure alpha” – only to collapse just a few years later.
The erratic nature of alpha poses a particular problem for large asset owners, who may suddenly have to rethink their allocations of billions or trillions of dollars in capital. When you’re dealing with such a vast pool of capital, it’s a little like piloting a huge aircraft. It takes awhile to get up to speed, and you can’t suddenly change direction.
Individual investors also need to be cautious. As alternative investments like private equity and hedge funds become available for individuals, more people risk being misled by the alpha mirage.
It’s easy to fall for the hype or get confused by acronyms and buzzwords. In the next blink, we’ll take a closer look at the true nature of alpha – without the jargon.
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What is Better than Alpha about?
Better than Alpha (2021) encourages investors to let go of their obsession with alpha – the amount an investment has returned compared to the market index. It explores what really drives returns, so you can build a successful portfolio and meet your investment goals instead of chasing rainbows.
Who should read Better than Alpha?
- Investors who want to make better decisions and improve their portfolios
- People with an interest in behavioral finance
- Anyone who wants to see through the hype and learn the truth about alpha
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