Alpha is the measure of returns different from the expected risk-adjusted return. Increasingly, investors have begun to use the term to refer to their outperformance relative to a benchmark.
Analysts and investors use various methodologies, like the Capital Asset Pricing Model, to calculate the appropriate return for an investment based on the risk involved. Alpha expresses the difference between that expected return and the actual return. If a portfolio has a positive alpha of 1, it outperformed its benchmark by 1%.
Alpha is most commonly used to evaluate the performance of an actively managed portfolio, and has become a measure of the value added by the portfolio manager. By comparing portfolio returns to a benchmark - usually composed of similar types of assets - investors can evaluate whether they are actually receiving value from their manager or if they would be better off with a passive (and thus lower fee) index fund.
For fund managers, quantitative analysts, and individual investors, positive alpha is A Good Thing.
Recent Mentions on Fool.com
- Starbucks' Delivery Pilot Program Is Ramping Up
- Foresight Energy's Stock Declined 25% in November Thanks to a Weak Coal Market
- Does Apple Inc. Truly Face a ?Virtual Reality Risk??
- Last Week's Top Healthcare ETF
- 5 Things Pandora Media, Inc.'s CEO Wants You to Know
- 5 Things Buffalo Wild Wings Management Wants You to Know