Confessions Of A Recovering Alpha Junky

by: Cullen Roche

For most of the last 20 years, I've been an alpha junky. That means I was obsessed with trying to "beat the market" and generate excess return. And I was pretty good at it. At one point, I was on a 10-year streak with no negative calendar year returns. Between 2005-2012, I ran an event-driven stock picking strategy that averaged almost 14% per year during a period when the S&P 500 annualized 2.5%. Not bad for a young punk who knew a lot less than he does now.

The financial crisis changed me though. Thanks to good luck, I pulled the ripcord on the event-driven strategy around April of 2008 and sat on my hands for about 6 months. When the correlations of all assets started veering towards one as 2008 progressed, I realized that nothing works all the time. I realized that I needed to expand my thinking and think of things in a more macro manner. I also realized that my original stock picking strategy was unscalable and I seriously questioned whether my high excess returns were the result of skill or just a bull market. I wasn't sure, but I was sure enough to hedge against my own hubris. So I continued to run the same basic event-driven strategy in the coming years, but I layered on more macro-oriented indexing type strategies. I was evolving away from the alpha junky I once was, but I still had a problem.

The light bulb really came on around 2012 when I realized that the term "investing" is one of the most abused terms in finance.¹ I recognized that the term "investment" has nothing to do with buying stocks and bonds and was instead all about spending for future production. We don't "invest" in the secondary markets. We allocate our savings. This was important because this was the moment when I realized that I had been chasing my own tail all this time. People don't get rich "investing" in the stock market. After all, stocks and bond values are derived from the way that the underlying entities spend for future production. People get rich creating things for future production.² Stocks and bonds are just the instruments that finance that spending at times.

The other big light bulb came on when I realized that "beating the market" has nothing to do with meeting your financial goals. In fact, alpha doesn't even exist in the aggregate and has been proven incredibly difficult to consistently generate. This reinforced the idea that my original success "beating the market" was probably a lot more luck than I originally thought. But more importantly, it helped put things in the right perspective for me. I realized that beating the market wasn't a financial goal of mine and that it isn't a financial goal for anyone. In fact, I realized that it's usually just a HOPE that high fee fund managers sell to their clients in exchange for the GUARANTEE of higher fees.

Of course, I still believe in active management. But that's because my rigorous empirical approach to all of this has led me to the conclusion that everything is active to some degree. But my recovery from being an alpha junky has helped me become a smarter form of active. It's been a long road recovering from being an alpha junky, but that's how I arrived at the place where I am as an advocate of globally diversified low fee indexing. Here's to hoping I can stay on the wagon!

¹ - Technically, "investing" means spending for future production. This is done primarily by firms who issue stocks and bonds to raise capital for future investment. When those shares trade on a secondary market they do not finance investment. They are simply being reallocated by savers. Most of the people we call "investors" are not really investors at all. They are simply savers trying to build an appropriate portfolio to help them meet their financial goals.

² - Contrary to popular opinion, most financial experts and mainstream economics, "saving" is not the key to financial success and does not create or finance future financial wealth. Investment is what adds to aggregate savings and increases the value of our future production.