The Sustainable Active Investing Framework: Simple, But Not Easy
A cura di Wesley R. Gray, Alpha Architect
The debate over passive versus active investing is akin to Eagles vs. Cowboys or Coke vs. Pepsi. In short, once our preference for one style over the other is established, it becomes a proven fact or incontrovertible reality in our minds.
This post is not meant to convert a passive investor into an active investor; however, we do explain why we believe some active investing approaches can logically beat passive strategies over a reasonably long time horizon (clearly it won’t work forever). Our framework also helps investors decipher the quantitative “factor zoo,” to determine if data-mining computers have actually identified a sustainble active strategy or a pipe dream.
We cannot overemphasize that identifying sustainable alpha in the market is no cakewalk. More importantly, being smart, having superior stock-picking skills, or amassing an army of PhDs to crunch data is only half of the equation. Even with those tools, you are still only one shark in a tank filled with other sharks. All sharks are smart, all sharks have a MBA or PhD from a fancy school, and all the sharks know how to analyze a company. Maintaining an edge in these shark infested waters is no small feat, and one that only a handful of investors has accomplished.
In order to achieve sustainable success as an active investor, one needs skill, an understanding of human psychology, and an appreciation of market incentives (behavioral finance). We start our journey where mine began: as an aspiring PhD student studying at the University of Chicago. Let the adventure begin…
Into the Lion’s Den: Pitching Market Inefficiency in the Land of Efficient Markets
I entered the University of Chicago Finance PhD program 13 years ago (Fall 2002). It was the beginning of a painful, but highly enlightening journey into the world of advanced finance. For context, the UChicago finance department maintains a rich legacy associated with having established, and successfully defended, the Efficient Market Hypothesis (EMH). PhD students in the department spend their first 2 years in grueling, graduate-level finance courses infused with highly technical mathematics and statistics. The final 2-4 years are dedicated to dissertation research. I would describe these conditions as: “sweatshop factory meets international mathematics competition.” The program was tough.
After surviving my first 2 years of intellectual waterboarding, I needed a break. I took a unique “sabbatical”, and decided to join the United States Marine Corps for 4 years. Long story short: I wanted to serve and I wasn’t getting any younger.
I returned to the PhD program in 2008 to finish my dissertation. My time in the Marines taught me a lot of things, but one lesson stood out from the rest: “Make Bold Moves.” And of course, what is the boldest move one can do at the University of Chicago?
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