Coffee Break Session:
What Is Alpha Investing?
Jason Campbell, Strategic Treasurer
Paul Galloway, Strategic Treasurer
Episode Transcription - (Coffee Break Session Series) - Episode 67 - What Is Alpha Investing?
Jason Campbell 00:03
Welcome to the Treasury Update Podcast, Coffee Break Sessions presented by Strategic Treasurer covering foundational topics and core treasury issues in about the same amount of time it takes you to drink your cup of coffee. I’ll be your host Jason Campbell, business development leader at Strategic Treasurer. Alright chatting with me today is Paul Galloway, Senior Advisor at Strategic Treasurer. Hey, Paul, how’s it going today?
Paul Galloway 00:26
Doing great, Jason.
Jason Campbell 00:27
Awesome. Fantastic. Well, listen. So, you know, we had a great conversation around the introductory into the Greeks from the investment topics and, and I found it absolutely fascinating covering each of those measurements of risk. And I want to dive in a little bit deeper on this session, as we continue the Greek theme coming into this coffee break session around alpha. So I know in the last session, alpha wasn’t necessarily mentioned, but I know it’s an important piece of the investing. So I just wanted to see necessarily, you know, when you dive in a little bit deeper with alpha and kind of explain what alpha investing actually is.
Paul Galloway 01:01
You can think about alpha or a as the way to approach active investing. This refers to the ability of a portfolio manager to deploy an investment strategy that beats the market. For instance, assume the market is represented by the S&P 500. If the market returns 10% for a given period, and a portfolio manager generates an overall portfolio return of 11% for the same period, the alpha return generated is equal to the 11%, the portfolio manager earned less the market return of 10%, which is 1%.
Jason Campbell 01:46
You want to find a way to win, right and I’m competitive, I’m sure many people, you know, in any business, you’re looking for that ways to get that victory those wins, and definitely trying to beat the market sounds inviting. But do a lot of people even beat the market?
Paul Galloway 01:59
As great question. While there are portfolio managers out there that do beat the market, only 15 to 20% in a given year, who will actually beat the market. The rest of them, they’re losing, they’re not meeting market returns. Warren Buffett has had a long standing bet that you can’t beat the market return. Meaning, you can’t beat the S&P 500 over this period of time, which has been for several years, it’s held up. So it’s a difficult thing to do. And there’s a lot argument for why not just invest in the market versus being active.
Jason Campbell 02:40
Walk us through a little bit about the difference between active investing versus passive investing.
Paul Galloway 02:47
Active investing will be what we just described at the very beginning of the podcast, it’s the Alpha investing. You’re making decisions around the portfolio mix that make the investments, or the characteristics of the investments different than the underlying benchmark or the market, in this case, S&P 500. If I’m passive investor, alls I’m gonna do is buy the market. So I’ll just buy the s&p 500. I accept the market returns. So market goes up, market goes down, my return should match in lockstep with the S&P 500 because that’s what I bought.
Jason Campbell 03:32
Gotcha. Why engage in active management though, if investing in the market works, majority of the time?
Paul Galloway 03:38
Think about what we talked about in our prior podcast around the efficient frontier. And this concept or the idea of not every investor is the same. There is this level of risk tolerance and ability to make riskier investment decisions that will drive a certain subset of investors to go after alpha returns. If you think about institutional investors, for instance, so this will be companies, insurance companies, pension plans, downpayment, funds, foundations, they’re making long term investments, and they’re making them in a variety of different asset classes. They may put an allocation to Alpha investing or alpha Portfolio Manager to try to get a better return than what the markets providing. They’re always trained to beat the market. And why is that? Because in many instances, they have an agreement somewhere along the way, that they’re going to provide some beneficiary a return a certain return on the investments. So there’s a liability, there’s a balance sheet, there’s a set of liabilities or set of assets. They want the asset returns to beat the committed liability returns, whatever is greater than what they committed to, they get to keep.
Jason Campbell 05:15
Well Paul, like always, thank you so much for joining me today. This was a fantastic session and I really do appreciate it. And for our listeners, please ensure to tune in every first and third Thursday of the month for a new episode of the Coffee Break Sessions. As usual, if you have any questions, comments or suggested topics, please send us a note at firstname.lastname@example.org. Until next time, take care.
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A part of the Treasury Update Podcast, Coffee Break Sessions are 6-12 minute bite-size episodes covering foundational topics and core treasury issues in about the same amount of time it takes you to drink your coffee. The show episodes are released every first and third Thursday of the month with Host Jason Campbell of Strategic Treasurer.