Michael Hanson
Business in Review

For Whom Does the Grail Serve?

By, 03/28/2011

The Quest for Alpha: The Holy Grail of Investing—Larry E. Swedroe

Through the span of human history, one of the great questions ever considered is: Whom does the Grail serve? It’s the foundational question of all chivalry and the spirit of the Middle Ages. This single inquiry reflects the powerful and profound expansion of the consideration of human spirituality and psychic development through that era.

No matter who you are—be you Percival or Galahad himself—you’re not there until you can answer that question. It’s sort of the West’s version of a Zen koan poem—not until after a lifetime of exploration and dedication can you even approach the question with clear eyes. Pop culture generally wants to think about the Grail as something to be obtained, the object of the quest. That’s only superficially what it is—the idea is to experience the journey in getting there, the adventure that it takes you on. It doesn’t matter if you hold the thing in your hands or not.

So I had to pick up Larry Swedroe’s The Quest for Alpha: Holy Grail of Investing. Surely market outperformance is no Grail legend, but in my experience, money management is a long, winding, and often harrowing adventure full of nobility and muck and all in between. Also, The Quest for Alpha is a very good book. It’ll be too jargony in spots for the hobbyist, but it delivers a clear message: It’s brutally difficult to beat the market consistently over time. Too many forget this too often.

We’ve covered the issue of passive versus active investing in past columns (here and here), so we won’t do it again. But, in sum, Swedroe offers a concise and compelling account of what the preponderance of data clearly shows: Markets are very efficient and most folks would be better off investing passively.

Especially provocative is Swedroe’s attack on behavioral finance, which posits that markets are hugely inefficient. Swedroe simply asks: If that’s so, why aren’t more folks outperforming? Because, even if there are “clear” market inefficiencies, they are hugely difficult to actually take advantage of.

Now, this line of thinking can go a bit too far. Swedroe’s point that the average investor has little chance of outperforming is true enough, but that doesn’t mean skilled professionals haven’t done it over the course of long careers—it’s just comparatively rare. That’s an important distinction. Also, passive investing feels right but is actually tremendously difficult. One reason to find a good, disciplined money manager is to help you not make all the mistakes you’d otherwise make. Put it this way: You might think in the rational light of day you can always be cool as a cucumber. But was that true at the nadir of 2008, when markets were down over 50%—with your retirement assets on the line, perhaps? Did you sit tight? And if you did, was it easy or agonizingly difficult? Most folks in my experience simply don’t have that kind of self control.

Another important lesson, and one that I encounter often when speaking with investors: There’s this myth that more information or more hard work will lead to greater returns. It simply doesn’t—you can put 25 hours a day into your analysis, but if your worldview and strategy are skewed, you’re cooked. Swedroe outlines this concept nicely, in addition to pointing out the inherent misalignments of incentives versus client needs within the industry.

A couple things to quibble with: Swedroe contradicts himself when he says there is no advantage in creating alpha with small cap stocks, even though their liquidity and availability of information is lesser than big caps; but later says managers who use “closet indexing,” and thus make their portfolios bigger and more benchmark-like, have less ability to outperform because there is more information and analysis out there on big cap stocks. Both those statements can’t be true—there’s either an informational small cap effect or there’s not (my view is, there’s not).

Also, Swedroe finishes the book with a John Bogle-esque admonishment about when “enough is enough.” That once you have enough assets to be comfortable with the basics, you should rein in all your risk. This is poor advice. One, there just aren’t that many folks out there who are so rich they can abdicate the growth equities offer over long periods. The vast majority of investors—ostensibly the ones Swedroe is speaking to—need some degree of growth over fixed income to fund their retirements.

But these are small things in the context of an otherwise worthy effort.

I don’t claim to know, but I think this much—the point of the adventure is the conflict, the movement itself. That’s where life is. Once you reach the goal—once you obtain—that’s when stories end. The Grail legend is a deep metaphor for human spiritual and psychological development. This has never been a story about finding or getting something—but market outperformance can often seem so elusive.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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