15/08/2017
[Creating Alpha – Through the Art or Science of Investing?]
Alpha refers to the excess return generated by an investment.
Excess return is the difference between a portfolio’s return and the market benchmark return. For example, if the market benchmark (say, in Malaysia, using the KLCI return) is 10%, and a portfolio achieves a 15% return, then that portfolio has generated an Alpha of 5%.
But to create Alpha — is it an art or a science? This is actually a point of debate.
The Science of Investing
The science of investing (favored by left-brained thinkers) involves using data, statistics, and formulas to calculate a stock’s intrinsic value, earnings ratio, asset utilization rate, debt ratio, cash ratio, dividend payout ratio, reinvestment rate, return on equity (ROE), return on assets (ROA), and free cash flow, among others, to assess a stock’s investment value.
It may also include technical analysis, where various indicators are used to determine the best timing for entering and exiting a stock.
In addition, statistical methods such as standard deviation can be applied to measure a stock’s price volatility, helping investors to evaluate and adjust portfolio risk.
The Art of Investing
The art of investing (favored by right-brained thinkers) relies on personal observation and intuition to make investment judgments.
This includes sensitivity to macroeconomic and microeconomic trends, the ability to interpret market data, identifying the flow of hot money into certain industries, and evaluating the future growth potential of a business.
In technical analysis, even with the same price chart, different people may have completely different interpretations. Those with strong intuitive abilities may detect subtle market psychology (fear and greed), investor sentiment, and potential breakout patterns from candlestick formations.
Art vs. Science in Practice
Some believe that fundamental analysis is art, while technical analysis is science — but this is not entirely accurate.
When fundamental analysis relies on formulas and statistical methods, that’s science.
When technical analysis involves using intuition and experience to interpret subtle signals in price movements, that’s art.
Finding Balance to Create Alpha
To create Alpha — that is, to beat the market — every investor uses a different mix of art and science.
Some rely purely on science (left-brained), some purely on art (right-brained), while others blend both approaches (using both hemispheres together).
Each method has its own strengths — the key lies in understanding your own nature and strengths as an investor.
At Yi Gu Hui You (Investors’ Club), our approach is roughly 55–60% investment art and 40–45% investment science.
We believe that market psychology and sentiment play a critical role in investing — hence, we place slightly more emphasis on the art side.
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