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In five decades the markets have gone from what could almost be described as sleepy, dominated by individual investors’ buying and holding stocks and bonds, to one wholly dominated by institutional investors, professional asset managers and Jetsons-like technology. These investment pros — lured by the possibility of unbelievable wealth and willing to work a lot harder than George Jetson’s typical two hours a week — have done everything they can to gain an edge over their rivals, hiring the best and the brightest to make use of innovations in everything from physics and engineering to biology and philosophy. This intense competititon for an edge has reduced the amount of aggregate alpha available in the market.

Unlike in other fields, such as medicine, where scientific advances have measurably improved lives, investors are not better off in this hypercompetitive world. In today’s investment industry alpha — a measure of a manager’s skill that arguably was always hard to find — is now rare. It’s the result of a phenomenon not exclusive to investments. As the skill of all the players in a game rises, luck increasingly influences who wins and who loses. In baseball, players are now uniformly better than they were a generation or two ago; that’s what happens when you start coaching kids in kindergarten. Whether ball meets bat can often depend on extraneous factors like wind speed. But baseball, in the end, is a game. The stakes are higher in investing, whether the savings are for retirement or for a college endowment.

An e-mail in January from Robert Willis, the 58-year-old CEO of an investment management firm in Gainesville, Georgia, reopened my research into what happened to alpha. Willis, an earnest Southerner who loves to debate the reasons investors fail in their pursuit of alpha, was responding to an article I had written on Duncan’s research that found institutional investors were flocking to alternatives despite admitting that they worried about how well they understood the complexity of these products. That made no sense to Willis, who keeps a three-ring binder of photocopied articles and research on mistakes that investors make, and in his estimation was further evidence that investors just blindly copy what others are doing — hoping and praying for success.

Investing has become increasingly professionalized since the 1970s. Once the historic bull market kicked off in 1982, managers aggressively expanded and targeted would-be clients with one promise: phenomenal returns. It then became a furious race to get those returns. Add in dramatic improvements in computer technology, with pocket-size devices with the processing power of mainframes that once filled buildings and an Internet communications system that can relay information in nanoseconds, and the markets have become hypercompetitive, where few brilliant professionals can get an edge. The word “edge” itself has taken on an insidious tone now that hedge fund firm SAC Capital Advisors is facing criminal charges for failing to supervise traders who profited from insider information.

Just because alpha has gotten harder to find, we shouldn’t let investment managers off the hook, says Clifford Asness, managing principal of Greenwich, Connecticut–based AQR Capital Management, which runs $84 billion in traditional and alternative strategies. “Where I’m sensitive is that people use this as a bit of an excuse,” he adds. The 46-year-old Asness, who was head of quantitative research at Goldman Sachs Asset Management before co-founding AQR in 1998, is one of the funniest people in finance and can find humor even when talking about a subject as esoteric as alpha. He wants to make sure I know that alpha has always been difficult to locate. “Predicting the future is harder than misremembering the past,” he says. “When I hear some market strategist say, ‘It’s hard to forecast the market right now,’ I always want to scream, ‘When was it easy?’”

It’s easy to see why institutions are desperate for alpha. U.S. corporate pension plans face an almost $700 billion hole in making good on their promises to retirees, while U.S. public pension plans confront a $4.4 trillion deficit, according to a 2012 study by Harvard University’s John F. Kennedy School of Government. And those numbers don’t include individuals saving on their own. According to the Employee Benefit Research Institute, baby boomers, born between 1948 and 1964, need an additional $4.3 trillion to retire.

Any story about alpha would be incomplete without Peter Lynch, the legendary manager of Fidelity Investments’ Magellan Fund from 1977 to 1990. Lynch, who now invests his own money and that of the Lynch Foundation from an office at Fidelity after driving Magellan to a 2,700 percent return during his tenure, retired at 46, leaving finance before technology and a new generation of professionals and academics would transform the markets. A Boston Red Sox fan, Lynch became synonymous with the terms “four-bagger,” “five-bagger” and, of course, the Holy Grail of investing: the “ten-bagger” — making ten times your money.

Although he is almost synonymous with the word “alpha” in academic circles, Lynch starts out our conversation asking me to remind him what it is. Clearly, he doesn’t think, and never has thought, in terms of alpha and beta (market performance). Lynch’s secret was to buy a lot of stocks based on fundamental research, knowing that most would be mediocre, some would do “okay,” and a few would do really well. He didn’t feel he needed to own every winning stock to be successful overall, and he eschewed thinking of investing as a science that somehow could provide foolproof answers. “For the math to work, you only have to be right six times out of ten,” he says. Lynch also had a good sense of behavioral mistakes; he held on to winners, letting them run, but was very willing to cut loose his mistakes, even if that led to losses. And he acted contrary to the crowd, investing in stocks when “things were going from crummy to semicrummy,” he explains. “By the time things are great, it’s usually too late.”

For Lynch alpha was easier to get in the beginning than at the end. Mauboussin points me to the work of finance professors Jonathan Berk and Richard Green, which shows that between 1977 and 1982, when the market was still below its 1966 high, Lynch produced a mind-boggling 2 percentage points of gross alpha a month. During his last five years managing Magellan, Lynch delivered 0.2 percent monthly in gross alpha, as the fund had grown from about $40 million when he started to $10 billion in assets.

Alpha didn’t matter as much in the 1980s and ’90s because there was so much beta. The S&P 500 returned more than 17 percent a year, on average, during the ’90s. If you were making double-digit returns, you weren’t very concerned about whether your fund manager was adding much — or anything — over the index.

Rosalind Hewsenian, CIO of the Leona M. and Harry B. Helmsley Charitable Trust, remembers those days well. “Most of my career was dominated by the twin rallies of the stock and bond markets,” says Hewsenian, who was an investment consultant at Wilshire Associates in Santa Monica, California, from 1985 to 2006. “Alpha was achieved by simply tilting risk a little higher than the markets generally, and you could outperform.”

One reason alpha has become more difficult is that the pioneers grabbed the good land. Investors benefited from the profits to be had in whole new categories of investments, such as high-yield bonds and the ability to tap international markets. “Some of the low-hanging fruit has been plucked,” says Robert Hunkeler, who has overseen International Paper Co.’s pension fund for more than 16 years. “When I think back to the ’80s and early ’90s, it wasn’t uncommon that a large allocation to international equities would have given you a big leg up over your competition. High-yield bonds were still called junk bonds, and many people didn’t invest in them because of that. Those were what I call cakewalks.”

The investment management industry is built on the premise of picking winners — alpha generators like Peter Lynch. That’s why I called Mauboussin early this year to talk about The Success Equation, a book he had just published on the role that luck plays in a variety of activities, including investing and sports. Mauboussin, who had recently left Legg Mason, and I compared notes about such things as the role that luck played in how we got our first jobs. I asked him what surprised him the most in his research, and he said it was the paradox of skill, a concept developed by the late biologist Stephen Jay Gould to explain that in many fields, as people become more skilled, luck ironically becomes more important in determining outcomes. “Absolute skill rises, but relative skill declines, leaving more to luck,” Mauboussin explains.

The charismatic Mauboussin, whose fully formed thoughts pour out of him with barely an “um,” asked me rhetorically how that could work. Gould wrote a book to explain the paradox, focusing on why the last baseball player to hit above .400 was Ted Williams in 1941. The answer, Mauboussin explained, was that the quality of the players was uniformly better than in the past, so all those great batters were hitting against equally talented pitchers. That meant the difference between the best players and the average players had narrowed.

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