Business, Legal & Accounting Glossary
Alpha is a measure of residual risk of an actively managed investment relative to a market index composed of similar investments.
Alpha is generated by regressing the investment’s excess return on the benchmark excess return. The benchmark could be a stock index such as the S&P500. The beta adjusts for the risk (the slope coefficient). The alpha is the intercept.
Alpha, the first Greek alphabet letter, is also the risk-adjusted measurement investment term for “excess return”. For example, an alpha of 1.5 means a fund outperformed the market by 1.5%. Alpha in a stock portfolio is the measure of a manager’s ability to select stocks that outperform the market return, often benchmarked by the S&P500, across a defined time period. Alpha is also applied more generally to rate any active portfolio manager return performance, because alpha means the risk-adjusted portfolio or investment return above any assigned risk benchmark or above the risk-free investment rate applied to calculate the alpha measurement. Alpha, the excess return above the market, plus the “beta” or market return, is then, the total return for the period on the portfolio. “Portable” alpha as often referred to by hedge fund managers, is alpha that can reduce risk or increase a portfolio’s alpha return with non-correlated strategies that contribute to risk adjustment for the entire portfolio. Alpha excess return theory can trace its roots to CAPM and other risk adjustment finance return measurement models that define risk benchmarks.
Alpha signifies how an investment has performed after accounting for the risk it involved. If Alpha is less than zero then the investment earned too little for its risk. If Alpha is zero then the investment has earned a return adequate for the risk taken. If Alpha is greater than zero then the investment has a return in excess of the assumed risk.
As an example, a return of 20% may appear good, the investment can still have a negative alpha if it’s involved in an excessively risky position. Alpha is commonly used to assess active managers’ performances.
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This glossary post was last updated: 23rd March, 2020