In this edition of The Most Misunderstood Investing Concepts I discuss the notion that \u03b1 is creativity. In case you have missed other pieces in this series here are links to each of them:<\/p>\n
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Creativity is Ignored<\/strong><\/p>\n If I were to ask an audience of investment professionals to name the most important investment skills, I am guessing that most would choose things like analysis, rational or logical thinking, and so forth. This view of things likely stems from several sources. First, when considering terms like, \u2018research analysis,\u2019 or \u2018financial analysis,\u2019 we are primed by that word analysis. In turn, \u2018analysis\u2019 indicates analytical and that word is typically associated with rationality and logic. Great, I get it. But successful investing is so much more than just analysis. It is a wise blend of both analysis and innovative thinking, and it is creativity that is the source of differentiated and outstanding investment returns. But creativity is only rarely discussed in the world of investing. For example, it is not something specifically hired for by firms. Nor is it the subject of investment education and training. And the word itself almost never is a part of intrafirm discussions. In short, creativity is ignored.<\/p>\n <\/p>\n A Crucial Analogy<\/strong><\/p>\n An analogy makes clear just why ignoring creativity is one of the investment industry\u2019s Achilles\u2019 heels. Investing is like detective work. Imagine a crime scene, say a bank robbery, to which 10 detectives are asked to solve the crime. Yes, there is something to be said for the analytical firepower used to gather important facts. Things like, fingerprinting, security camera footage checks, witness interviews, a review of current or recent disgruntled employees, and so on.<\/p>\n While these things are certainly necessary, they are not sufficient to solve the crime. No, the detective that solves the crime is the one whose creativity allows her to identify which facts, from among possibly thousands, are the crucial facts. Not only that, but it is also the detective who can creatively piece the facts together into a meaningful narrative that explains the crime that is likely to solve it.<\/p>\n I would love it if you would receive notification of my new articles \u2013 sign up here<\/strong><\/a> \ud83d\ude42 Don\u2019t forget to comment on the article in the space below. Thanks!<\/p>\n <\/p>\n This is just like in investing where almost every player is well schooled and beyond expert at the tools of the trade like financial statement analysis, and valuation. Likely they have access to and attempt to digest vast amounts of data. Even the sophisticated math and statistics used to try and find signal from among the noise of data is likely based on well-known statistics. They may even have artificial intelligence and machine learning enabled data gathering devices deployed using off-the-shelf solutions.<\/p>\n The point is that everyone is playing in this space, meaning that these efforts are \u03b2 efforts, and not \u03b1 efforts. Overwhelmingly, most of the value add is provided by creativity not technical advantage. Yet, the investing world misunderstands that alpha is creativity.<\/p>\n <\/p>\n A Definition of Creativity<\/strong><\/p>\n It may seem that creativity defies defining. Yet, creativity researchers in education, psychology, and neuroscience have spent over one hundred years gaining fluency in the subject. Most have converged on an understanding of creativity that is something like:<\/p>\n It is the ability to produce work that is novel (that is, original, unexpected), high in quality, and appropriate (that is, useful, meets task constraints).<\/p>\n Can you see just how similar this definition is to that of that most golden of investing outcomes, \u03b1? Here is the definition of \u03b1 from Investopedia<\/a>:<\/p>\n Alpha is used in finance as a measure of performance, indicating when a strategy, trader, or portfolio manager has managed to beat the market return over some period. Alpha, often considered the active return on an investment, gauges the performance of an investment against a market index or benchmark that is considered to represent the market\u2019s movement as a whole.<\/p>\n Here is how they are analogous:<\/p>\n <\/p>\n To me, alpha and creativity are equivalent terms. Thus, if you want to beat the market then, by definition, you must be creative. For greater details on creativity, including its necessary conditions see my series of co-authored with Focus Consulting Group\u2019s founder, Jim Ware.<\/p>\n\n\n
\n Key Words Defining Creativity<\/u><\/td>\n Key Words Defining Alpha<\/u><\/td>\n<\/tr>\n \n \u2018novel\u2019<\/td>\n \u2018has managed to beat the market\u2019<\/td>\n<\/tr>\n \n \u2018high in quality\u2019<\/td>\n \u2018gauges the performance of an investment\u2019<\/td>\n<\/tr>\n \n \u2018appropriate\u2019<\/td>\n \u2018against a market index\u2019<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n