Alpha: Can You Beat The Market?
For many investors one of the lingering uncertainties is whether or not we are better-off pursuing an active investment strategy, or whether simply placing funds into a professionally-managed or low-cost index fund, would yield higher returns.
In this issue of Bullseye Insights we take a closer look at a key measure of investing performance - Alpha - and whether investors are wasting their time fighting against the odds by attempting to beat the market.
So what is Alpha?
Alpha is a measure used by professional investors to quantify an ability to beat the market - or at least achieve better returns than the market as a whole. Remember: even in a bear market, it is still an achievement to beat the market.
Alpha is commonly represented as a percentage, with either a positive or negative value. As such, an alpha of zero indicates that an investment's performance is tracking perfectly with the comparative benchmark or index chosen, and that the investor has not added (or lost) any value when compared to the broader market performance.
An investment that outperforms the 'market' has a positive alpha value. Underperformance versus the 'market' results in a negative alpha value. For the purposes of an Alpha calculation, the 'market' is represented by a relevant market benchmark or index, such as the FTSE100.
For example, if the benchmark return is 5% over a given time horizon and your investment returns 8% over the same period, the Alpha would be +3% (i.e. 8% - 5% = 3%).
If the same investment returned only 4%, when compared to the same benchmark over the same time horizon, it would have a negative Alpha of -1% (i.e. 4% - 5% = -1%).
Alpha is a simple and effective way for an investor to measure relative performance, and goes to the heart of answering that very important question: am I adding value, or simply wasting my time?
Did you know?
Legendary investor Warren Buffet believes most investors would achieve better returns by investing in an index fund as opposed to trying to beat the market. He believes that any active return fund managers make will eventually be eroded by fees. Research from S&P and Dow Jones indices supports Buffet’s thinking. Data revealed that active investors who outperform against a benchmark over a one-year period have a less than 50% chance of outperforming it again by the same rate in the second year. The study also found that, even if investors had a successful three-year record of generating active returns, they underperformed the benchmark in the following three years.
At Bullseye we believe strongly that intelligent investing requires active monitoring of performance, and basing trading decisions on facts, using tried and tested technical and performance-related indicators to inform, rather than listening to self-appointed social media experts or chat forum trolls.
That is why we view Alpha as a key indicator for all investors no matter whether you are novice or seasoned pro. It is also why we have built functionality into our platform to allow users to measure their performance over varying time horizons against established international market indices - such as the FTSE100, S&P500, EuroStoxx50, Nifty50, HangSeng and many more.