Book Review: Better than Alpha

Better Than Alpha: Three Steps to Capturing Excess Returns in a Changing World. 2021. Christopher M. Schelling. McGraw Hill.

Better Than Alpha: Three Steps to Capturing Excess Returns in a Changing World, by Christopher M. Schelling, principal of Austin, Texas-based investment firm Windmuehle Funds and former chief investment officer of private equity for the Municipal Retirement System of Texas, is a valuable resource for professionals seeking a more complete understanding of alpha, including what it is. that is, how to identify it and what they should focus on. The author’s three-step framework behavior (configuration of policies and strategic allocations), process (selection of managers and tactical assignment), i organization (types of authority, supervision/attribution, and delegation) provides a more optimal way to think about alpha. Instead of simply trying to beat the market, investors should make decisions that increase the likelihood of achieving their investment goals.

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Behavioral alpha (intelligent thinking) is the excess return that investors can earn by overcoming their behavioral biases, rather than beating the market. Humans use two primary systems of thought. System 1 is a fast and intuitive processor that favors efficiency and speed, but often leads us astray. System 2 is a more deliberate and logical process, but it’s also a lot more effort. Since system 2 consumes much more energy than system 1, our natural tendency is to avoid it. We all have limited time, resources and mental acuity. According to the author, we can mitigate the errors of our System 1 thinking when making investment decisions without simultaneously overexerting the limited decision-making resources of System 2, simply by not using System 2 as much.

Investors should prioritize the most important and impactful decisions and systematize as much as they can of the rest. For example, rational investors should not allocate the same mental energy to a $1,000 business expense and a $100 million private equity investment. A strategy provided by the author that allows for greater parsimony with System 2 is simply to make fewer important decisions. The less often a decision is made, the more appropriate it is to implement System 2 thinking. The more often a decision is made, the more likely System 1 will hijack the thought process at some point, regardless of one’s intentions. Highly impactful and infrequent decisions, such as setting policy and selecting asset allocation, merit System 2 decision-making efforts.

The alpha process (intelligent habit development) is derived from high-quality knowledge that facilitates the selection of managers with a relatively high probability of achieving investment objectives. Smart habits include systematizing as much of the investment process as possible and automating what works to be more efficient and accurate. Examples include the use of intelligent checklists to help managers select more efficiently and informed rebalancing methods that remove the emotion of keeping the portfolio in line with long-term goals. These smart habits limit the opportunities for cognitive blind spots to negatively impact your portfolio and help drive successful results. Behavioral alpha and process alpha are about being the architect of one’s own investment behavior rather than its unwitting victim.

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Finally, organizational alpha (smart governance) is the improved return on investment that results from better organizational decision-making. Governance means properly ensuring that an institution has the right people in the right positions to make the right decisions. For an investment organization to succeed, the most qualified person must decide and the best ideas must win. According to the author, if the organization cannot get experts in hierarchical positions, it should push the real authority to the relevant experts, internal or external, and ensure that they are doing their jobs. In this way, an institution will have a better chance, compared to more hierarchical and bureaucratic structures, of achieving its overall policy and investment objectives. Inefficiency has a real cost; removing it is how organizational alpha can be easily achieved.

In short, this book provides the knowledge and tools investors need to save time, resources, and most importantly, mental and emotional energy to improve their investment results. Instead of acting like ghost hunters chasing alpha, investors should focus on making decisions that create a higher probability of achieving their investment goals.

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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.

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Mark K. Bhasin, CFA

Mark K. Bhasin, CFA, is a senior vice president at Basis Investment Group, LLC, New York, and an adjunct associate professor at New York University’s Stern School of Business.

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