The Quest for Alpha by Larry Swedroe – a Book Review

quest for alpha

When Larry Swedroe’s newly released 163 page personal finance book, The Quest for Alpha, was released in February, I rushed to order a copy. 

Knowing that the book wouldn’t be available in Singaporean bookstores for a few months, I ordered it via Amazon.  And I was glad that I did.

Swedroe, who has written numerous books aimed at helping the small investor, weaves a plethora of evidence together, demonstrating that investing in actively managed mutual fund products (which most people buy) is statistically inferior to building portfolios of passive index funds.

Here are some of Swedroe’s arguments that struck me as particularly powerful:

1.  The fund rating agency, Morningstar, rates funds based on a five star system.  Funds awarded “Five stars” are those with the best track records.  And most investors and financial advisors pour money into those.  But Swedroe eloquently demonstrates that choosing a five star fund, based on its past performance, is actually the kiss of death. 

2.   The examples he provides for the superiority of passive investing are varied, coming from sources such as magazine writers, Economic Nobel Prize Winners, Ivy League Economics professors, active fund managers, and superior investors (such as Warren Buffett).  If you’re wondering why I’ve listed “magazine writers” as my first example above, there’s a reason for that.  To change the old saying just a bit, magazine writers are likely to tell you, after they’ve had a few drinks, “Do as I do, not as I write”.  Magazines aren’t generally good places to go for investment advice.

3.  Then there’s the poor overall performance of Hedge Funds and Pension Funds, compared to diversified accounts of indexes.  Larry Swedroe has really nailed this one.

4.  If you’re a keen personal finance follower, you might think that Peter Lynch had the best actively managed fund during the 1970s, with Fidelity Magellan.  But it wasn’t number one.  Providing a great example of how historical fund performance is a poor future indicator, Swedroe outlines a fund that outshone Lynch’s fund.  Any guesses how it did in the following decade?

What Canadians might find illuminating:

I also enjoyed reading Swedroe’s account of CIBC bank’s push for index fund products in the mid 1990s.  CIBC’s Ted Cadsby wrote a book about the superiority of index funds, but then the bank ordered him to “quiet down” as they ventured into purchasing a collection of high cost mutual fund companies.  The bank knew that if their spokesman was touting index funds, their institution would make far less money. 

What Swedroe didn’t note here, was that CIBC raised its index fund expense ratios shortly after Cadsby’s book was published.  And their fees were 6 times higher than Vanguard’s index fund fees.

That would have furthered Swedroe’s premise that most financial institutions are out for their own profits, at the expense of the little guy.

The only thing I think this book could improve on would be the title, The Quest for Alpha.  Everyone who earns a paycheck should read Swedroe’s book.  But few common folk will know what Alpha is.

I hope that doesn’t stop people from reading this marvellous little book. 

 





Andrew Hallam

I’m a financial columnist for Canada’s national paper, The Globe and Mail, as well as for AssetBuilder, a financial service firm based in Texas. I’m also the author of Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School (2nd Ed. Wiley 2017) and The Global Expatriate’s Guide To Investing: From Millionaire Teacher to Millionaire Expat (Wiley 2015). My mission is to educate, motivate and inspire people on basic retirement planning and best practices for investing, using evidence-based strategies. I’m happy to comment on your questions. However, please read the Terms of Use, Privacy Policy and the Comments Policy.

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7 Responses

  1. DIY Investor says:

    I agree on the title. Most people wouldn't know by looking at the title that it is an investment book. I will shamefully admit that I thought about writing a post about "What is Alpha" and looked it up under Google "keywords" and saw there have been practically zero searches on the term as related to investing. I'll probably still write the post sometime, but still supports your point.

    "The Quest to Beat the Stock Market" or something similar would have IMHO a better chance of finding the buyers Swedroe's seeking.

    • Hey Robert,

      I wouldn't be ashamed of that post title. We sometimes get really close to something and forget that it won't be understood by others. Think of how many times our brains do that when we write things. I remind my students of it all the time. It happens.

  2. I've been reading Swedroe for years. He is one of the few in the blogosphere and on radio and in the bookstores who is truly trying to help the individual investor. The Morningstar rating system is a lagging indicator, not a leading indicator, and those fund coming off a period of overperforming the market are likely to underperform in the future.

  3. You're absolutely right about Morningstar Biz. The interesting thing is that more than 90% of fresh money gets tossed at Morningstar's 5 star funds each year.

    It becomes harder for them to outperform. Many end up suffering from "Elephantitis" and they revert back to the mean, earning an indexed return (or below) before their fees, and below an index return after their fees. Plus, the managers end up with more money than ideas.

  4. Bhaskar Naik says:

    Hi Andrew: The 3 index funds that you are investing in, are they ETFs? Will you be willing to name those funds — almost all of my savings (including my wife's) are in poor-performing mutual funds recommended by an advisor at my bank. The funds are mostly from the bank! I have opened an account with a discount broker and want to start converting my investments into ETFs.

  5. Hi Bhaskar,

    Suitable exchange traded funds for you could be determined by your country of residence. For example, a 35 year old Singaporean would be wise to have 25%-35% of his/her money in a Singaporean bond ETF index, and the remainder of their money split between the Straits Times ETF index and a world stock market ETF index. This would give them a "home country" bias, which is always a good idea, considering that their future bills will be paid in the currency they reside in.

    An American would have an American bias; a Canadian would have a Canadian bias.

    Please let me know if you have other questions. If you're curious, you can see the exchange traded funds that I own in my last post: the one about me being lazy!

    Thanks for the question!

    Cheers,

    Andrew

  6. Nice article Andrew! I'll add Larry's book to my shopping list.

    I agree with you and DIY Investor, could have had a better, more catchy-title.

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