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 doing this a long time. Including five years holed up with a "quant" whacko who couldn't so much as flip a sofa cushion without finding "alpha." 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, beyond 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 trillion-dollar hedge-fund industry. Kind of remarkable, since I remember paying nearly that much for some wise guy to teach me that alpha doesn't exist!
And for years, that's what I believed. Sure, I'd seen investors beat the market. Then I'd seen them get crushed. Chet Hammersmith would get a hot hand loading us up on Cisco
Now it gets good …
So when my friend and colleague David Gardner started telling me he'd captured 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 back in 1997, before it went on a 2,800% run.
Not to mention Amgen in 1998 and AOL in 1994, the latter at $0.43 a share. The guy has a nice touch, but that's a far cry from generating true, positive alpha. And remember, I barely believed that alpha even existed!
That's where the NASA guy comes in. First, he used his big brain 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 Gardner is feeding into his supercomputer to make it spit that alpha out. Oddly enough, it's you. Seriously.
You see, Gardner 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. This "community intelligence" supported his belief that Netflix
He tapped into it again when he recommended that we buy Marvel Entertainment
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 things
We discussed how Gardner's "NASA portfolio" outperformed 99.4% of 25,000 random stock portfolios. But if you're like me, that sounds like a lot of big numbers. Here's a second experiment that convinced me that these guys might really be on to something.
This time, they applied their model to a handful of real-life portfolios -- namely, the stocks recommended in The Motley Fool's 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 legit.
Across six different advisory services -- recommending stocks as diverse as Microsoft
Fewer picks, higher returns
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.
If you own a mutual fund, give this try. Cross-reference your fund's alpha with its managerial tenure. (Morningstar's "Risk Measures" tab is a good place to start.) If you find high alpha (the higher, the better) and your manager's been at it five years or more, you may have found one of the few gems in the mutual fund world.
As you probably know, David Gardner's been collecting intelligence data from more than 125,000 visitors to our Motley Fool CAPS 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. Gardner insists he has tapped the collective intelligence of the world's smartest investors -- and more important, he can use this data to help you make money in your portfolio. Here's how he plans to do it.
Along with longtime Fool analyst Jeff Fischer, Gardner is investing $1 million of The Motley Fool's real money in a long/short portfolio of stocks, options, and exchange-traded funds. They aim 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. Starting today, David will be inviting a small number of Fool readers to follow along with his experiment in real time. In fact, he will 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.
This article was first published Oct. 14, 2008. It has been updated.
Paul Elliott owns shares of Pfizer. Microsoft and Pfizer are Inside Value selections. Pfizer is also an Income Investor pick. Amazon, Netflix, and Marvel are Stock Advisor picks. The Motley Fool owns shares of Pfizer and has a disclosure policy.