Chasing alpha – Aren’t market returns sufficient?

To all alpha chasers – “Don’t risk what you have and what you need for what you don’t have and don’t need.”

I am sure you have been in a situation on the road, when you see vehicles in the other lane moving faster, manoeuvre yourself to get there, only to realise that the lane you just left is speeding away. “What a fool!”

Something similar is happening to the investor in the stock markets, direct or through equity mutual funds.

For a long time, the investor was spending time and effort in looking for the best of the fund managers delivering the highest returns. This search was made as if it was no less than the search for elixir of life.

Unfortunately, that search seems to be turning sour now, forcing investors to think if these actively managed specialist fund managers can really deliver the goods. Is alpha really possible?

Should the money be moved to index funds?  

At the end of 2018, given the way markets were, several investors wondered if they were better off with passively managed equity index funds / exchange traded funds (ETFs).

“Of course, there is a recency bias working here. Many of these investors are new having made their entry in the last couple of years. But they are shaken up with the sharp gap between what the market has delivered and what the actively managed fund has.” I wrote then.

“I am not really sure if this is just recency bias or the wind has really turned. “

“It was the recency bias. Look at the comparisons now and you will know.”

That only makes things worse for the lay investor.

Should I chase that alpha with the active fund?

However, I have another question to ask.

Do you need that alpha?

What if I ask you to assess and find out how much return do you really need? No, don’t say maximum, highest, best returns.

Spare me the superlatives!

What if you take a different approach and ask how much is enough?

How much do you need to meet your goals, to live a good life, to take care of needs and some wants of your family?

I have come across several investors who can just do with market returns. While it is good to have a better return, they don’t need that alpha.

If you too are an investor of sufficient means, adequate asset base and are saving enough on a regular basis, should you be bothered about beating the market at all?

Why make all the effort in looking for alpha fund managers, comparing various funds, their portfolios, paying extra management fees and other taxes. Is it worth the while?

Probably, that’s where index investing makes sense.

Index investing

One of the most advertised benefits of index funds is that they are simple, low cost and just about deliver the goods, that is, close to market returns.

No worry about changing funds because of fund managers’ lukewarm performance or paying high costs in the hope to get a pot of gold at the end of the rainbow (read superior returns), waiting for you.

Those in favour of active investing will come out with the arguments about portfolio quality and risk management.

To which the passive investor can simply say, “Portfolio be damned.”

Who needs a fund manager designed portfolio which falls as much as the market and sometimes fails to match up when the market is on the ascent?

With a Nifty or Sensex based index funds / ETFs, you get an exposure to some of the largest and most liquid companies traded on the exchanges. Even if there are a few bad apples, that’s fine.

There is no special knowledge and rare, if it is, that can outdo the collectively functioning brain of the market.

As a summary, the questions are –

• Is alpha possible?
• At what risk?
• What cost? 

It then moves further to –

Why not just invest in passive index funds? Aren’t market returns sufficient? 

Remember the famous saying: “Don’t risk what you have and what you need for what you don’t have and don’t need.”

Stick to your lane and you will reach your destination, give or take a few minutes.

What do you think?

—

Yet another approach

…could be dividing the portfolio between core and tactical. A large part of the portfolio should be structured to deliver market returns with passive strategies.

However, if you are the adventurous kinds, the tactical portion can be used to chase some of the opportunities in the active space or any other structures that may deliver higher returns.

I have been working on the same for some time. If you are looking at core and tactical MF portfolios – here’s something you would want to look at.

—

As always, do share your feedback and comments.