Jensens Alpha

Jensen's Alpha is a risk-adjusted performance metric that measures the excess return a portfolio or investment generates compared to its expected return, given its risk as measured by the Capital Asset Pricing Model (CAPM). A positive alpha indicates that the portfolio has outperformed the market on a risk-adjusted basis, while a negative alpha suggests underperformance. It is commonly used by investors and fund managers to evaluate a portfolio's ability to generate excess returns beyond what is expected from market movements.

Example

A mutual fund with a positive Jensen’s Alpha of 1.5% means the fund has outperformed its expected returns, adjusted for market risk, by 1.5%.

Key points

• Measures a portfolio's excess return compared to the expected return based on risk.

• A positive alpha indicates outperformance, while a negative alpha signals underperformance.

• Commonly used in evaluating the risk-adjusted performance of portfolios or mutual funds.

Quick Answers to Curious Questions

What does a positive Jensen’s Alpha indicate?

It indicates that the investment or portfolio has outperformed its expected risk-adjusted return, signaling good performance by the fund manager.

How is Jensen’s Alpha calculated?

It is calculated by comparing the actual return of a portfolio to the expected return based on the Capital Asset Pricing Model (CAPM).

Why is Jensen’s Alpha important for investors?

It helps investors assess whether a portfolio manager is generating returns above what is expected for the level of risk taken.