Alpha and beta are two key measurements used to understand the performance of a fund, stock, or portfolio. Typically, these measurements are used to assess investor performance compared to competition or peers.
Alpha measures the return that the stock or portfolio has achieved relative to the market index or other benchmark. Needless to say, the more alpha, the better the performance.
Beta measures the risk or volatility of a stock or portfolio compared to the market volatility. This helps investors to identify how much risk they are willing to take to achieve returns. This is measured with 1 as the market volatility, so anything under that is less volatile than the market, and anything over that is more volatile.
Ultimately, investors typically look to achieve as high alpha as possible, with as low beta as possible. However, this will depend on the investor's style.
These two terms have been the primary method of measuring performance, but in a passive investment market, what do they really mean? In recent years, passive management strategies have seen more and more investors simply follow the crowd and manage similar portfolios. This investment model achieves relatively low alpha, with a low beta.
Investors need to find new ways to achieve alpha, or risk flatlining performance.
The economy is facing one of the most challenging periods in recent times. A variety of political and economic factors have meant that investors are now facing a bear market. Achieving alpha is more important than ever before.
However, it’s also more challenging to achieve alpha than ever before. With limited investment, and markets struggling to tread water, investors are less willing to take relative risks.
In a bear market, passive investment strategies just cannot perform. The less investment, the less movement on the market. All investors follow the same funds, data, and advice. Lack of variety is continuing to reduce returns.
Investors need a new approach to increase the opportunity for returns, while still maintaining a comfortable beta.
Smart beta is an investment strategy that aims to combine the benefits of passive and active management approaches. The primary goal is to obtain alpha, improve diversification in a portfolio, or manage risk with lower costs than active management. This involves utilizing alternatively-weighted indices. However, the fact remains, this is still a passive strategy.
The same challenges appear with the smart beta approach. Following an index in this way leads to a group-think, or homogenization. Everyone follows the same strategy in the end.
When the market begins to return to normal, there will be clear winners and losers from the current economic situation. Those that follow the same strategies will be the losers, and those with innovative strategies will be the winners.
This doesn’t necessarily mean that achieving alpha is easy in the current market. There are still considerable challenges to face. Overall, there are three major hurdles to overcome to improve returns:
1) Too much data: Big data is taking over the world and the financial sector is no different. There is more and more data accessible to investors, being made available by companies and third parties. It’s impossible for investors to analyse billions of data points in order to make clear predictions or forecasts. However, it’s only natural to want to use all available data. Data continues to fuel the markets, and investors aren’t exempt from that.
2) Too little time: With so much data, and such a fast-moving market, investment managers struggle to keep up. You need to make your decisions quickly, leading to investments that feel safe, rather than those that drive alpha.
3) Too much noise: With so much data available, much of the available information is unorganized and becomes noise. How do you break through that noise and find the information that is truly valuable to inform your investment decisions?
In alpha vs beta investing, investors need a tool that overcomes these challenges and allows them to achieve their full potential.
At 3AI, we believe that AI is the solution to these challenges. The technology has the capacity to handle and leverage huge volumes of data in moments. However, not all Artificial Intelligence (AI) technology is built the same. There are key components needed to generate an AI solution that works for the finance market.
Firstly, AI for investments cannot operate on unstructured data. Ultimately, what goes in, must come out. If you give AI systems poorly organized and messy data, it will provide messy, unusable forecasts.
A deep factor framework that analyses and organizes databased on hundreds of factors, ensures that data is usable, both for the AI and the end user. At 3AI, our AI technology breaks data into 326 individual factors, with the goal to provide complete data transparency for users.
We combine this factor framework with explainable AI technology. Our goal is to provide investors with complete clarity on AI and Machine Learning processes. We believe that the best AI tools augment investors, rather than replace them. Explainable AI and a deep factor framework allow investors to evaluate each decision made by the AI system, and make decisions accordingly.
We believe that this combination is currently the only way to improve AI adoption in the financial sector. Investors must trust the technology to unlock the potential of big data analysis for alpha performance.
At 3AI, our team began in the investment industry. We knowhow challenging the increase in data and the need to obtain alpha is for those in the sector. That’s why we set out to help investors understand the market.
We believe that AI is the tool that investors need to bring alpha back in such a difficult financial environment. AI technology helps you to harness big data and transform it into actionable and tenable insights for improved performance.
Interested in learning more? Get in touch with us today!