Elusive Alpha

Dennis Davitt from Millbank Dartmoor Portsmouth was interviewed by Citywire USA. The main takeaway from him is that very few investors create genuine alpha and that very few of those make their alpha generating process available via some sort of fund, hedge or mutual. 

Some conversations about alpha drift into being very academic especially the theories about alpha being zero sum. This conversation drifts into the academic realm a little but raises an interest question about how much or how little alpha does the typical person who saved for retirement, trying to make it through and maybe leave a little bit for their kids actually need?

A point we've been making here for ages is that with an adequate savings rate, appropriate asset allocation and the ability to avoid succumbing to panic, an investor should be able to have retirement plan success as defined above. Embedded in the part about appropriate asset allocation is that they capture most of the effect of what equities do over their long term. 

This is an actual performance chart. Most of the outperformance came during the GFC. There have been plenty of shorter periods of underperformance and some with outperformance. They've generally captured what the market has done since the inception of the account. That would be true in my opinion if the account total and benchmark were flip-flopped. The person has been retired the whole time. The spending habit is not sky high but has been running a little over 4%, quite a bit over in some years.

What do you think actually matters here? "You lagged by x%/outperformed by x%" or "I don't think you should take your regular $4000/mo out for a few months/no you shouldn't take an extra $5000 this quarter to pay for your grandson to do that activity?"  

Again, you need to be reasonably close but the typical person, as opposed to a hedge fund manager, does not need to chase performance. A strategy that you have reason to believe will work and that you can live with volatility-wise is all you need IMO.

 

Obviously if you need normal stock market growth for your plan to work, as most people do, then the red line won't cut it. 

A few weeks ago we looked at something called the Dragon Portfolio which looked to me like a variation on the permanent portfolio. Dragon allocates as follows.

 

And the result as Portfolio 1 versus 100% equities and 100% 60/40.

 

VIXM is a client holding.

The compounded annual growth rate for Dragon for the last ten years using ETPs is sub 2%. I'll bet it back tests better to capture gold in the 1970's and far more (all?) of the 40 year bond bull market. Part of the pitch for Dragon is preserving generational wealth. If that is your objective than something like the red line in my chart above would work, something like Dragon as I have captured it would also work. None of my clients are concerned with generational wealth. Plenty want to leave something to their kids which is different and one has a son about my age who will need meaningful financial support for the rest of his life. That one is the closest to a generational wealth objective as their accounts need to last for the son's lifetime but there's been no mention of beyond the son's lifetime. 

At 56, if I had $10 million dollars and wanted to retire I could get away with the red line above or a return profile that looks like Dragon. Are you in that situation or some variation of it? I have clients who are and they have slightly different versions of game over. 

The red line portfolio and Dragon or something similar is not good or bad, it is either appropriate or it isn't. For anyone for whom these are appropriate, they really shouldn't be worried about alpha. If you're 60, think you want to retire at 65 and need $1.4 million to do so and have $1.3 million now, how concerned should you be about alpha? I'd argue not much. 

The bottom line importance is having enough to make your financial plan work without being a nervous wreck all the time and without having to say no to your grand kids for financial reasons (life lesson reasons are a different story).