Compound or Alpha?

Daljit Singh Kochhar is the founder of KT Advisory, a boutique strategy consulting and investment banking practice based in New Delhi. He has effectively counselled executive boards at multinational companies, operated and led change in a logistics business with a revenue stream more than US$ 2 billion, guided family run businesses towards institutional funding; and conceptualized and delivered real estate projects. Daljit is a keen distance/ marathon runner and a wannabe (barbeque) pitmaster.


Alpha is the holy grail for Investment Managers. Can a single-minded focus on it be costing you, Mr. Investor?


Alpha (α) refers to the excess return earned on an investment over a benchmark. It may well be the reason for actively managed funds to exist. For, if they cannot beat the benchmark, say the NIFTY50 (for a portfolio of actively managed large caps), they are not earning their keep.


There are not many things that legendary investor Warren Buffet and Eugene Fama, the Nobel Prize winning Professor at the University of Chicago, would agree on as it pertains to stock picking and efficient markets. Except, both are firm believers in index funds.

The Father of Modern Finance has a litany of academic research citing the inability of active managers to beat market indices. And the billionaire investing genius regarded as the Grandfather of investing states in his 2013 letter to the Berkshire shareholders that his advice to the trustee of his estate is to put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.

Both believe that the secret to long-term returns is to settle for the average, and not chase the alpha. 


As equity investing, via mutual funds and the direct route, continues to grow in India – Mr. Investor must educate himself on the various products available in the capital markets and their suitability to him based on investment time frame and risk appetite. He must enquire about their 3-to-5-year (and beyond) track record on beating the benchmark and not get dazzled by absolute returns. SPIVA India research of five-year data as of December 31, 2021, shows that 82.3% of funds have underperformed the S&P/BSE 100. If Mr. Investor relies on a mutual fund distributor to show him the lay of the land, he must also understand his incentives. To the uninitiated, fixed income products generally give lower incentives to distributors. I was once offered to invest in a super alpha generating venture debt product (AIF) when my ask was the safety of fixed income – debt was the common feature, I suppose!


Warren Buffet simplifies investing using baseball analogies. Our Mutual Funds Sahi Hai campaign also features two of our cricketing stalwarts. I am sure you have read investing gyaan in context of ODIs and Test Cricket before. So here is another analogy – this one highlighting how sports are different to investing.


In a knock-out game, a team in a tough spot needs to go into high gear. The players must try their moon shots, for if they do not win the game – they get another shot at the title in 4 years. There can be only one champion. Go big or go home is the mantra.


This is not the case in investing.


Many a charlatan equates taking risk as a precursor to earning high profits on Dalal Street. There is something seductive about making outsized returns. There are scores of investors that have sworn off the capital markets after making large losses following such risky stock tips or lumpy market timing efforts. This is most unfortunate, as equities remain a superior asset class to compound wealth over the long term.


Wealth goals are better served if we focus on compounding rather than chasing super alpha. We will come out ahead if we aim our investment portfolio to be consistently average rather than the star of the next cocktail conversation. A risky bet that takes the investment corpus down 50%, will need to double from thereon only to break even.


Mr. Investor should be wired to celebrate India reaching the #1 position in Test Cricket more than winning the next ODI World Cup. 



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Interested in how we think about the markets? Read more: Zen And The Art Of Investing

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