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.