Fundamentals: Alpha vs beta

Alpha vs beta

Let’s start with the definitions:

Alpha

Excess returns you gain over the market.

  • Only available to you.
  • Requires you to have an edge (information that’s not baked into the price already).
  • Zero-sum game. If you gain, somebody loses.
  • Short-lived. As soon as the market finds about your edge, it’ll arbitrage it away.

As a retail (non-institunioal) investor, your alpha (edge) sources are limited. Anything well-known is probably arbitraged away already (if it can be), by the time the info reaches you.

Related note about “the unnecessary urge to search for alpha”

Beta

Returns attributed to taking a “risk premium”.

  • Available for anyone.
  • Doesn’t require any edge.
  • Non-zero sum game. You, and everyone else gains.
  • Long-lived. As long as the vehicle / market works, it’ll be available for everyone.

Beta can manifest itself in various ways:

  • Seeking yield (eg. buying bonds)
  • Value (eg. buying relatively cheap companies)
  • Growth (eg. buying stocks that are on a good trajectory)
  • Selling insurance (reducing someone else’s exposure to volatility)

You can diversify your beta (risk premium) exposure with a market-cap weighted index fund, like the S&P 500, or an Aggregate Bond fund.