Mobile phone usage has been soaring for years, which means demand for phones, phone apps, and phone services. The simple investment thesis would be to go long telecommunications and tech companies related to this industry—so how would such a hypothesis perform over the last three and a half years?
Let’s say we want to create a portfolio that is diversified around telecommunications providers and tech firms closely connected to the mobile phone sector. That means we want AT&T (T), Verizon (VZ), T-Mobile (TMUS), and Sprint (S) for telco, and Google (GOOG) and Apple (AAPL) for cell phone app and hardware providers.
Back in late 2011 when we wanted to build this portfolio, we might also want to choose a tech infrastructure provider. There are a lot of them, but let’s go with Cisco (CSCO) because of its track record. Then with security issues becoming a concern in 2012 and 2013 with several hacking scandals, we might also be tempted to jump into FireEye (FEYE) at the time of its IPO. Let’s also pick T as our telco stock, to make things easier. Over the last 3.5 years, here’s what our portfolio would look like:
Assuming equal weighting, that portfolio earns a 69.48% return over the last 3.5 years, or 16.27% annualized. That compares to a 15.52% return for the S&P 500 for the same time period. So there is some alpha there.
But not much. Firstly, one has to consider how management fees from a fund manager would obliterate that 0.75% alpha. Plus, this portfolio is heavily concentrated in two sectors that are really closely correlated. That means more risk, and lower risk-adjusted returns relative to just buying an index fund.
Plus, this is assuming you kept T and not the alternatives. An aggressive bet with S or TMUS would have massively underperformed. VZ would have added about a percentage point to total returns over the entire time period, but the lower dividend would have negated that. This means even the best case scenario fails to deliver alpha.
This exercise makes a simple but important point: investing on a broad observation will usually not outperform. Investors need to do much more due diligence and analysis of markets to deliver alpha, and that means a lot of analysis, reading, homework, and learning. Just betting on growth of mobile usage isn’t enough—one needs to realy learn and understand what “mobile” is and who is going to benefit from its growth. Then, and only then, will big alpha finally appear.