Double Alpha: Beating the Index and Beating the Fund Manager
In investing, generating alpha—excess returns over a benchmark—is the ultimate goal. However, there’s an often-overlooked second layer to this: not only do fund managers strive to generate alpha over the index, but advisors and allocators also aim to generate alpha over those fund managers. This creates a "Double Alpha" challenge:
- Fund Managers’ Alpha Over the Index
- Advisors’ Alpha Over Fund Managers
Let’s explore how both layers work and what it means for investors.
1. Alpha Over Index: The Fund Manager’s Edge
Fund managers attempt to beat their respective benchmarks through active management strategies such as:
- Stock Selection – Picking undervalued or high-growth stocks.
- Sector Rotation – Shifting exposure based on macroeconomic trends.
- Factor Investing – Leveraging styles like momentum, value, or growth.
- Market Timing – Adjusting portfolio allocations to exploit market inefficiencies.
While some managers generate alpha, studies show that many fail to outperform their benchmarks after fees over the long term. This leads investors to question: How do we identify skilled managers?
2. Alpha Over Fund Managers: The Advisor’s Challenge
Financial advisors, wealth managers, and institutional allocators take on the next challenge: selecting fund managers who can consistently outperform. Their alpha comes from:
- Fund Selection Skill – Choosing managers with repeatable investment processes, rather than just past performance.
- Fee Optimization – Balancing cost vs. return by assessing whether high-fee funds justify their expenses.
- Risk Management – Avoiding managers who take excessive risks to generate short-term gains.
- Behavioral Oversight – Preventing investors from chasing performance and falling into common investing pitfalls.
Is Double Alpha Worth Pursuing?
While the pursuit of alpha at both levels is appealing, it’s also challenging:
- Persistent Alpha is Rare – Many fund managers revert to the mean over time, making the advisor’s selection process even harder.
- Fees Matter – Each additional layer of active management introduces costs that can erode returns.
- Alternative Approaches Exist – Some investors opt for passive indexing or factor-based strategies to capture market returns more efficiently.
The Future of Alpha Stacking
With advances in data analytics, AI-driven research, and factor investing, identifying skilled managers is becoming more systematic. Advisors who incorporate quantitative insights alongside qualitative evaluations may have an edge in achieving alpha over alpha.
In the end, whether you’re an investor, advisor, or fund manager, the key question remains: Are you generating true alpha or just adding unnecessary complexity?