Alpha

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Financial Terms and Glossary

Alpha

Alpha is a measure of an investment's performance relative to a benchmark index, representing the value that a portfolio manager adds or subtracts from a fund’s return. A positive alpha indicates that the investment has outperformed the market or its benchmark, while a negative alpha suggests underperformance. Alpha is a key metric in active management, where the goal is to achieve returns above the market average by making strategic investment decisions.

Example

If a mutual fund has a return of 10% while its benchmark index returns 8%, and the risk-adjusted difference is 2%, then the fund has an alpha of 2.

Key points

• Measures the performance of an investment relative to a benchmark.

• Positive alpha indicates outperformance; negative alpha indicates underperformance.

• Important in assessing the value added by active portfolio management.

Quick Answers to Curious Questions

What does a positive alpha indicate?

A positive alpha indicates that an investment has outperformed its benchmark index, suggesting effective management or strategy.

How is alpha used in evaluating investments?

Alpha is used to assess whether a portfolio manager has added value beyond what could be achieved by simply tracking a benchmark index, taking into account the level of risk taken.

Can an investment have a negative alpha?

Yes, a negative alpha means the investment has underperformed its benchmark, indicating that the returns were lower than expected given the level of risk.