Understanding Alpha
The ultimate guide to measuring active excess return.
Quick Definition
Alpha (α) is a measure of the active return on an investment, gauging its performance against a market index or benchmark. It is considered the "value added" or "subtracted" by a portfolio manager's decisions compared to simple market exposure.
Interpretation Guide
Alpha > 0
The investment outperformed the market, relative to its risk (Positive Alpha).
Alpha = 0
The investment matched the return expected for the amount of risk taken.
Alpha < 0
The investment underperformed the market given its risk (Negative Alpha).
Jensen's Alpha Formula
α = Rp - [Rf + β * (Rm - Rf)]
Why It Matters
An investment may have returned 15% when the market returned 10%, but if it took twice the risk to achieve that return (Beta = 2), the actual Alpha could be negative. Tracking Alpha ensures you are being compensated adequately for taking on risk rather than just riding a bull market.
Generate your portfolio's Alpha
Stress test your allocations to see if your active decisions are actually generating positive Alpha against standard benchmarks.
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