As the fourth quarter begins, Eight Ventures’ Smart Whales portfolio, our only all-stock portfolio, has beaten the S&P500 by 22.6% in 2020. Measured against the Dow’s stable of blue chips, the Smart Whales portfolio has outperformed by 27.4%. When markets dropped dramatically in the late-February-through-March timeframe, Smart Whales’ drop was shallow and the rally since late March has exceeded that of the broader market. This outperformance has been accomplished with a diverse portfolio of 20 stocks exhibiting less risk than either the S&P500 or the Dow Jones Industrial Average.
To analyze this, let’s employ the gold standard metric for measuring portfolio management, Jensen’s Alpha, which combines a portfolio’s returns and risk profile. Considering risk is always key when evaluating investment returns. Just think, if you are betting the farm for just a little more return in a bull market, you can actually beat the market and not have positive Alpha, or risk-adjusted excess returns.
Smart Whales seeks positive Alpha by leveraging the work of the world’s top performing buy-and-hold oriented investors, mirroring their strong conviction buys meeting certain criteria. The investment managers tracked by Smart Whales have created incredible wealth over the preceding decades and this model hinges on the simple presumption that our roster of young Warren Buffet’s will not forget how to make good money in markets.
Jensen’s Alpha for the Smart Whales portfolio: 22.6
(not an error; the Alpha happens to equal the outperformance number)
Every investor should demand a simple, powerful plan and their analysis should begin with the following questions about their current course of action.
- Do I have an investment strategy? Do I have good reason to believe it will work?
- What are my returns? Am I accomplishing positive Alpha?
- How much risk is in my portfolio?
In the end, if someone has beat the S&P500 by 30% in 2020 with a beta of less than 1, they are literally the .1% and should probably keep doing what they are doing. Conversely, in the instance that someone doesn’t have good answers to the questions above, they should interview a few investment advisers with a goal of finding one that does.
Additional Background (Nerds-only Section)
Jensen’s Alpha defined:
Jensen’s Alpha, also known as the Jensen’s Performance Index, is the gold standard measure of the excess returns earned by the portfolio compared to returns suggested by the Capital Asset Pricing Model (CAPM). Alpha is represented by the symbol α. The value of the excess return may be positive, negative, or zero. The CAPM model itself provides risk-adjusted returns, meaning it takes into account the risk of the security. Therefore, if a security is fairly priced, its actual returns will be the same as CAPM. The Alpha in this case will be 0. If, however, the security earns even more than the risk-adjusted returns, it will have a positive Alpha. Negative alpha indicates that the portfolio has not earned its required return. A higher Alpha is always desirable by portfolio managers. Jensen’s alpha focuses only on non-diversifiable, relevant risk by using beta and CAPM.
The formula for Jensen’s Alpha:
αp = Rp – (Rf + (Rm – Rf)βp
- Rp = Returns of the Portfolio
- Rf = Risk-free rate
- β = Stock’s beta
- Rm = Market return
The metric for portfolio risk is “weighted beta” (or “portfolio beta”). Using the S&P 500 as the benchmark, meaning the S&500 has a beta (or volatility) of 1, the Smart Whales portfolio has a beta of .9867. This means the Smart Whales portfolio is less risky than the S&P500.