If you think this story sounds too good to be true, I don't blame you. I was a skeptic, too.
And I've been at this a long time. That includes five years holed up with a "quant" nerd who couldn't so much as flip a sofa cushion without finding "alpha." Yeah, yeah, I know what you're thinking …
What the heck is alpha?
Without digging myself too deep a hole, "alpha" is the excess return you're earning on your stock portfolio above what some academic would expect given its level of risk. Put another way, alpha is the measure of your ability to pick better stocks than I can.
This much I know for sure: Alpha is the driving force behind a $1.2 trillion (and shrinking!) hedge-fund industry. Kind of remarkable, given that I vaguely remember paying nearly that much for some wise guy to teach me that alpha doesn't even exist!
And for years, that's exactly what I believed. Sure, I'd seen investors beat the market. But I'd also seen others get crushed. There just never seemed any rhyme or reason to it all. Chet Hammersmith would get a hot hand for a year -- and then get his head handed to him the next. And so it goes in an efficient market.
Now it gets good …
So when my friend and colleague David Gardner started telling me he'd captured the ever-elusive alpha -- and that he'd hired a NASA scientist to prove it -- I barely gave it a second thought. True, this was the guy who told me to buy Amazon.com (NASDAQ:AMZN) back in 1997, before it went on a 2,700% run.
Not to mention Amgen (NASDAQ:AMGN) in 1998 and AOL in 1994 at 43 cents a share -- long before the Time Warner (NYSE:TWX) debacle. The guy has a nice touch, but that's a far cry from generating true, positive alpha. And, remember, all I really cared about in terms of alpha was that I barely believed it existed!
That's when the NASA scientist started playing hardball. First, he used his big brain (OK, probably a MacBook) to randomly generate 25,000 hypothetical stock portfolios. Next, he created a portfolio of his own, using David Gardner's proprietary, so-called "alpha-generating" model. Turns out the NASA guy's portfolio outperformed 99.4% of the random portfolios.
Wait until you hear how he did it
Amazingly, that experiment isn't what changed my mind. Before I tell you what did make me a buyer, you must be wondering what David is feeding into his supercomputer to make it spit that alpha out. Oddly enough, it's you. Seriously.
You see, David has long argued that many smart, ordinary investors will always be smarter than any one "expert." He's been proving this theory in an ad-hoc fashion for years. He used what he calls "community intelligence" to confirm his outlook on game developer Activision Blizzard (NASDAQ:ATVI), for example -- the pick has risen by more than 500% since. It was a similar story in 2001 with eBay (NASDAQ:EBAY) and in 2005 with Intuitive Surgical (NASDAQ:ISRG), which has climbed by 407%.
According to David, what's changed now is that he's found a way to collect his community intelligence on a mass scale and "quantify" it. In other words, he's transformed a disparate bunch of opinions, insights, and bits of knowledge from something he could vaguely process in his own head into something a guy from NASA could stuff into a model.
The experiment that changed everything
We discussed how David's NASA portfolio outperformed 99.4% of 25,000 random stock portfolios. But if you're like me, that sounds like a lot of fancy numbers. Here's a second experiment that convinced me that he and his scientist might really be on to something.
This time, they applied their model to a handful of real-life portfolios -- namely, the stocks recommended in Motley Fool premium newsletter services. I like this approach for two reasons. First, these are real stocks, handpicked by real advisors in real time. Second, the guys who assembled these portfolios are good.
For example, when they ran the numbers on Sept. 12, David and Tom Gardner's Motley Fool Stock Advisor recommendations had risen by an average of 42%. That's darn good. Yet when David optimized the portfolio using just one criterion from his model, he increased those results by another 17.6 percentage points -- and just as important, he did this with significantly fewer picks.
This is no fluke!
In fact, when taken across six different advisory services -- recommending stocks as diverse as Microsoft and Bank of America (NYSE:BAC) -- the results held up. All told, David's "community intelligence" filter cut the number of picks nearly in half and increased the already blockbuster returns by a stunning 19 percentage points per pick.
So if you ever wondered how a NASA scientist would use your own intelligence to help you beat the market in theory, there you have it. Now, I'll tell you one way you can use alpha in your own portfolio, and then I'll show you how David Gardner proposes to do it on a grander scale.
Turning "alpha" loose in your portfolio is remarkably simple. If you're among the millions of investors who own a mutual fund, in fact, you'd do well to put it to work today. All you have to do is cross-reference the fund's alpha with its managerial tenure. (Morningstar's "Risk Measures" tab is a good place to go.) If you find a high alpha (the higher, the better) with a managerial tenure of five years or more, you may have found one of the few gems in the fund-manager world.
But back to David Gardner. As you probably know, he's been collecting intelligence data from more than 115,000 visitors to The Motley Fool website. Over the past few months, he assembled a team, including the NASA scientist I mentioned earlier, to help him analyze and back-test that data to consistently generate positive "alpha."
And he's done it!
Or so he assures me. David says he has finally tapped the collective intelligence of the world's smartest investors -- and more importantly, he can use this data to help you make money in your own portfolio. Here's how he plans to do it.
Over the next few weeks, David Gardner, along with longtime Motley Fool analyst Jeff Fischer, will invest $1 million of his company's real money in a long/short portfolio of stocks, options, and exchange-traded funds. The idea is to prove that they can combine their community-intelligence data and portfolio-management skills to thump the market with that $1 million investment.
Why should you care? Well, here's the thing. David will be inviting a small number of Motley Fool readers to follow along with his unusual experiment in real time. In fact, he will even announce his portfolio trades in advance -- so that you can buy (or short) ahead of him. But hurry, because the doors are closing in just three days.
If you're interested in learning more, check out this message from David Gardner himself. It could be just the thing you need to get you through this miserable market and out the other side with more money that you have right now. To hear it from David, and to receive a private invitation to learn more, simply enter your email address in the box below.
