Professions exist to deliver specific outcomes for their clients. Medical professionals cure the sick. Accountants ensure the accuracy of financial statements. Asset managers produce alpha; this is our business.
But while the term “alpha” is widely used, in our experience, it’s not particularly well understood. Alpha, properly defined, is return in excess of what could have been expected given the risks assumed. Notice that this is not strictly outperformance relative to a benchmark; rather, it’s relative performance given the level of risk taken.
The outcomes attributable to the efforts of investment professionals are admittedly more difficult to measure and judge than they are in medicine, for example. Further, over the past couple of decades, the tools and techniques that we use to measure performance, along with the increased availability and quality of data sets, show us that much of what we used to view as alpha was actually systematic exposure to a particular factor.
Granted, 10 to 15 years ago investors had little in the way of vehicles to harvest premiums to value or quality or low volatility, for example. Active managers who correctly divined that companies and stocks exhibiting those qualities offered excess risk-adjusted returns were rewarded. That was certainly alpha at the time because it took skill to identify the opportunity and to build a portfolio that capitalized on it while managing risk.
Today, those same risk premia can be harvested systematically and cheaply, and therefore calling them “alpha” is a stretch. So does alpha still exist?
Where to Find Alpha Today
At a time when the popularity of indexing has reached levels akin to Beatlemania, investors certainly seem to be saying that either alpha doesn’t exist or that it’s too difficult to identify managers on an ex ante basis who can produce it.
The standard bearers of this new world arguably aren’t in the same business as the rest of us. With every dollar raised in passive investment vehicles, these giant firms take another step toward exiting the investment business. After all, can a firm truly be considered an investment firm when it doesn’t make any investment decisions?