Sources of Alpha - A journey down the philosophical rabbit hole

At a recent meeting, a potential investor asked us a question that while we believed was implicit in our communications, required us to take a step back and reflect.

After presenting our strategy, he asked about the common threads that run through our principles, strategy, and process and how they contributed to our outperformance. Or, in other words, what are our sources of Alpha?

We put our heads together to consider how to articulate the common threads. 

We brainstormed and debated for hours, falling down deep philosophical rabbit holes at times.

We agreed on the following three main “sources of Alpha”:

1. Ethical-owner Framework

2. Applied Behavioural Science

3. Probabilistic Approach

Ethical-owner Framework

We think like business owners and therefore only invest in companies that are consistent with both our ethical and investing values. We view company management teams as our business partners and their actions, both positive and negative, reflect on us as individuals.

Moreover, because we view stocks as partial interests in real businesses and not as little tradable pieces of paper, we analyse them with the intention of holding on to them for many years.

Applied Behavioural Science

We believe that successful investors must understand their biases and limitations. Insights from behavioural science highlight the importance of actively correcting and controlling for biases. Checklists and behavioural rules have been shown to improve decision-making under uncertainty and complexity in many industries. Our proprietary checklist is at the heart of our process.

In addition to enabling us to manage biases, we believe that the scoring system we use helps us quantify the different qualitative factors that we use to evaluate companies. That then allows us to compare these factors across time and companies, which we believe drives consistency.

Probabilistic Approach

The world is too complex and uncertain to be dealt with using single-point estimates. By considering ranges in forecasts, valuations and risk management, we believe that we can tilt the odds of success in our favour, systematically and consistently.

Also, by forcing ourselves to explicitly pre-commit to specific ranges of inputs and assumptions, we end up with benchmarks against which we can compare actual future results.

The discussion on the above topic is by no means over, and we will continue to explore it in more detail in the future. To continue to perform for you, we must continuously improve and evolve to keep up with an ever-changing world. That requires both observation and introspection, combined with an open mind that has a willingness to update prior beliefs.