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I'll bite and say yes, I believe you can't generate alpha for all intents and purposes. I really like this illustration:
"A finance professor and a student are walking down a street. The student notices a $100 bill lying on the pavement and leans down to pick it up. The finance professor immediately intervenes and says, “Don’t bother; there is no free lunch. If there was a real $100 bill lying there, somebody would already have picked it up!”
Of course, this is a stupid joke, but I think a follow-up question is more important: Have you ever actually found a real $100 lying on the pavement in real life?
This is my sentiment on investing and 'generating alpha'. New information is being acted on immediately in the market, it is impossible for an average Joe like me (and, even though you may not want to admit it, like you too) to generate superior returns. Now of course someone, somewhere can generate superior returns (and boast about it on reddit), but determining whether or not this is as a result of 'alpha generation' or luck is impossible. Just looking at the law of large numbers, someone, somewhere, will find a $100 bill lying in Times Square, but it won't be me, and I won't spend time with a magnifying glass searching for it.
It’s becoming increasingly harder too. Like on some Moores Law type shit with the advent of AI now.
Seems like the way to generate some good ol wealth is to create a stupid but cute product that the slightly unsatisfied, deeply consumerist society would love purchase. Make it decently big, exit, have fun
This is generally my conclusion, but how do you feel about the idea that if everyone is passive, then everyone is piling into the same names and there's actually more opportunity for active management? Like right now, everyone is buying 7 stocks and the more money that goes into them, the more money that'll continue to disproportionately pile into them, making other names undervalued.
Therefore, if that's the condition, I actually do think right now we may be in a time period where active could have its place again. The problem is it's been brutal waiting for that downward catalyst for Mag 7 to arise and one has badly underperformed being underweight those names for years on end now. I started the rotation away from SPY/QQQ a bit early. While most of my money is S&P500 and I've still benefitted there, the other part has badly underperformed. I'm fine with it personally because I don't need all that growth and actually want to lower my portfolio's beta, but I imagine it's hard for people actively managing and having to explain to investors why they're paying 2/20 to underperform SPY
My feelings are quite mixed. First, I actually support active management in principle and believe it has a place regardless of market conditions. The reason is that active funds are what keep the market efficient. Suppose the market becomes so efficient that active managers, including exotic ones like high-frequency traders, go out of business because there’s no money to be made from market anomalies (through arbitrage, value investing, momentum, etc.). In their absence, the market would become inefficient as no one corrects the arising anomalies. If there’s no Citadel High-Frequency trader to notice that wheat futures in China are selling for 1 cent less on the Chicago exchange compared to Singapore, these anomalies would grow unchecked. This inefficiency creates an incentive for new active managers to enter the scene and exploit these opportunities. This cycle of entry and exit repeats, maintaining a state of equilibrium. The managers themselves keep the market efficient (at their own expense by earning subpar returns!!) This scenario is a classic example of game theory in economics. Regarding your point about the potential for active management now, it’s possible we’re at a point where new players are entering the market to exploit inefficiencies, which leads to my second point.
I don’t consider myself the smartest person, objectively speaking. There are people far more intelligent than me studying quantum physics, quantitative finance, and statistics. Whenever I think I’ve come up with a promising strategy, I remind myself that it’s virtually certain some quant, somewhere, has already analyzed it and found it to be shit; otherwise, it would have been exploited already. When I invest in the market as a whole, I benefit indirectly from their expertise and knowledge as they work to correct market inefficiencies. Of course, the market is not perfectly efficient and in hindsight, it's easy to say the market was not (2008), but I would argue it is practically impossible to say at the market is in(efficient) at any 'live' point in time. And if I can't, I'll just surf the wave rather than swim against it.
20% of the market is passive, not everyone
The key point, is that passive does not trade. Markets could still be efficient even if 99.99% of the market was passive
The flow into the SP500 affects all components in the SP500 equally. It does not increase NVDAs relative valuation compared to Mcdonalds, they stay the same. It's active participants that have set that relative price
Active management is a negative sum game after trading costs and management fees. You siphon superior risk-adjusted returns at the expense of other active participants
The worse participants get killed off every year and so the pool of active participants becomes exponentially more sophisticated over time. It's harder to generate alpha when you're trying to extract them from more sophisticated players over time
Market prices reflect the total knowledge of all market participants. The current price of stocks reflects the combined knowledge of tens of thousands of PHDs and short-term equity traders at places like Citadel, stat arb quants at places like RenTech, and analysts covering the stock to assure that the stock is priced accurately.
Private markets is the same story. PE used to be free money as there was a huge valuation gap between private and public markets, a leveraged value trade. It's a 1.2-1.5x beta product that makes you feel good because it's illiquid thus the illusion of low vol. PE takes 6% of AUM as management fees and the returns have been the same as public markets when the valuation gap narrowed
To generate alpha you have to be one of the smartest in the world, and the fastest. If 51% think the stock should be $10 or higher, and 49% think it should be below $10, and the minority is correct, then the 49% don't get the opportunity to short. The first firm (say, Citadel) that sees it's mispriced will take up all of the flow until it's corrected and the rest of the 48.99% won't get any of the pie. So you have to be quick.
Even playing a long game, price is not determined by what the majority think, it's determined by what the majority of $ think. So you can be smarter than 90% of investors, but the top 3% will have most of the money (RenTech, Jane St, etcetera), and they will keep buying your flow when your wrong.
You can find a mispriced security every now and again, but the chances you are able to find that again and again and again and be consistently right when the majority are wrong is highly unlikely. You can generate alpha in a year or three years, but to consistently see more opportunities than the smartest money out there is practically impossible. Alpha isn't impossible for you, but consistent alpha is.
If you plot the top money managers's time investing against annual performance since inception, it's a negative slope. The longer the best investors managed a portfolio, the worse their performance is.
It isn’t that it is physically impossible to generate alpha. It is that functionally no one actually does, and for those who do it is often tied to a very narrow set of time and circumstances.
There has been a lot of good studies on this. Most people’s returns are through strategy selection, not any actual ability to apply the strategy in a value-adding way.
the time and effort to generate alpha outweights its reward (unless you're managing extremely big AuM where 0.75% profit translates in big money). So for people managing small portfolios/individual, isn't worth it.
"Younger generation?" .....bruh....that's you. You're not a seasoned pro no matter how much posturing language you use. If you want to be grumpy about the future you're going to have to put in your time. "Just starting" your analyst stint doesn't entitle you to be salty yet.
No shit dude 😂
What is alpha?
Use substack regularly, but what’s VIC?
The opportunity isn't really there right now. Mostly because there's not enough "real" activity or "real" wealth to generate anything divorced from the actual productive process. This'll change eventually, but maybe not for the earliest length of our careers.
For sure, beating the market is incredibly hard - there are enough studies on this topic - but it’s not impossible. There are some great investors that generated extraordinary returns over a long enough period of time and without neglecting diversification completely. An aspect worth mentioning here is that statististically it’s possible that there is a small number of people that can generate alpha over a long period of time due to pure luck. But if you look at some of the best investors in the world you will notice that some of those people have been knowing each other for quite some time, even sharing the same mentor, etc. Imo to say these returns come from pure luck would be ignorant to some degree.
No normal person should be foolish enough to say he could beat the market. But the best of the best can.
One additional thought about the „efficiency of the market“: How can a market even be completely efficient? In many cases swarm intelligence might be right but not in all. Look at the Dotcom Bubble… The thing here is that the market trades upon expectations. There are also many studies about how much predictions of future earnings differ from the actual. Emotions also play a huge role when it comes to expectations, especially when we keep in mind that predictions of future earnings differ that much. In the Dotcom Bubble the whole market was trading internet companys only based on expectations, caring not at all about the actual figures. We all know what happend and we all can pull up examples of this behaviour which led to fatal results. How can this behaviour be called efficient? Trading companys one year in existance without profit 100x book value? The whole point of „goodwill“ is in it self inefficient. This does not mean anyone should have seen to crisis coming, but I believe there is room for it
Thats why I believe there are people who are able to generate alpha, but even if there are none, the market is definetely not efficient.
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