Alpha
In short
Return above what beta-adjusted market exposure would predict — skill vs luck
Alpha is the extra return a fund earns above what you'd expect given its risk. If the market returns 10% and your fund returns 13% with the same risk, alpha is 3%. Positive alpha = the manager adds value.
Alpha (Jensen's Alpha) is the return above the CAPM-predicted return. Positive alpha indicates outperformance; negative indicates underperformance relative to risk taken. Generating consistent positive alpha is extremely difficult and implies genuine skill or informational edge.
Formula
Alpha = Rp - [Rf + Beta × (Rm - Rf)]Thresholds
- <-2
- Significantly underperforming
- -2 to 0
- Slightly underperforming
- 0-2
- Slight outperformance
- >2
- Strong alpha generation
Related concepts
- Beta — Beta of 1.0 means the stock moves in line with the market. Beta of 1.5 means if the market rises 10%, this stock typically rises 15% — more volatile. Beta of 0.5 means less volatile than the market.
- Sharpe Ratio — Sharpe ratio measures how much return you get for every unit of risk you take. A Sharpe of 1.0 means for every 1% of risk, you earn 1% return above the risk-free rate. Higher is better.
- Information Ratio — If a manager beats the market by 2% per year on average, but the outperformance swings wildly (+10%, -6%, +2%...), the information ratio is low. Higher IR means consistent, reliable outperformance.