Are you an Alpha or Beta Investor?

One of the biggest debates in the investing community is whether the average investor should look for alpha or beta outcomes from his or her portfolio.

What’s the difference? Let’s take a look at each investment strategy and then you can finally decide which one best fits your needs.

The Alpha Investor

During financial forums and conventions, you’ll often hear active investors refer to their “alpha.” This is predominantly the amount by which they have exceeded (or underperformed) their benchmark index. For instance, if you invest primarily in Ugandan stocks, you might use the All Share Index(ALSI) as your benchmark.

For instance if the (ALSI) was up 5% over a given period of time, but your portfolio was up 8%, your alpha would be +3. If, on the other hand, your portfolio was only up 3%, then your alpha would definitely be -2. Alpha is basically the amount by which your return beats or lags an index with a homogenous risk profile.

Most investors, given the choice, would love to beat the index every year. Why would you want to settle for corresponding the index when you could actually try to exceed it? Precisely, beta investors might contend that very few, if any, active managers regularly beat the index, and that many actually under-perform. So, why even bother trying hard?

The Beta Investor

“Beta” refers to the degree to which a given investment or portfolio is more or less volatile than its benchmark index. A fund with a beta coefficient of 1 implies that it will move with the market. A fund with a beta of less than 1 will be less volatile than the market; a fund with a beta higher than 1 will be more volatile than its benchmark index.

Over the years, I’ve got to realise that beta investors are usually passive investors. They are not looking to outperform the markets. They prefer to take the, “If you can’t beat them, join them,” approach to investing. They will accept returns that merely match the index of their choice because they expect that markets will rise amidst their investing lifetime, as they have historically.

That begs the question: what if those historical trends don’t hold true any longer? What if markets take a dip, notably within a few years of retirement? One of the problems with corresponding the index is that you’re definitely going to have periods of negative returns. You can actually lose money over lengthy periods of time, as many passive investors have during the 2000 to 2010 time frame following different financial journals.

Beta investors would purely remind us that we need to reduce our investment risk tolerance as we age so that we’re not heavily invested in stocks during the 5 years before we retire (i.e. personal investment portfolio asset allocation). They would also forewarn that, for this strategy to work, you need to be able to sit tight through the downturns. If you sell during those drawdown periods, you’re presumably to end up with negative returns. To match the index, you have to stay with it.

Absolute Returns

Many investors, including myself, aren’t desperately concerned with how they perform relative to any index. They just want to see their hard-earned cash advance in growth over time with smart investment decision-making choices. Losing 8% in a year when the market was down 14% is cold comfort to the absolute return investor.

Absolute returns simply refer to the amount your portfolio has gone up or down over a given period of time, disregarding how any index performed over that time frame. But then how do you achieve consistently positive absolute returns? There are assumably hundreds of answers to that question. The key is to find the investment strategy that works for you.

Which Is Better?

Both alpha and beta investors can be very glowing about defending their chosen investment strategy. Alpha investors contend that many people can and do beat the indices quite on a regular basis. They are not interested in simply corresponding the index, and they hate the idea of losing money.

Beta investors conceive that the broad stock market indices will be positive over time, so they are comfortable gradationally adding to their positions and sitting tight for the long term. They conceive that negative returns for a short period of time are part of the cost of investing. They’re confident they’ll be ahead and have the money they need to retire with time.

Why not try a Hybrid Approach then

Some investors are hardwired to search for alpha. Others don’t trust in their ability to achieve alpha, so they take the beta route. Both are agreeable as long as they’re working. If you’re trying to use a beta investing strategy, but you just can’t keep your fingers off the sell button, you may want to look at some alpha strategies or even try a hybrid approach.

There are endless combinations of hybrid investment strategies. You could disect your investment capital into two pools, using a beta strategy with half and an alpha strategy with the other half. See which one consummates better over the course of a year. Which one made you feel more convenient? Could you try out a different alpha strategy to see if it works better for you?

Final Word

In the end, investors need to put their money to work in a way that appropriates their age, skill set, income, and risk tolerance. It can take some time, but finding what works for you is the best way to beseem a successful investor.

Now Sir/Madam what’s your investment strategy: alpha, beta, or hybrid?