Alpha

Alpha is the return above or below what an investment would have been expected to earn given the market risk it took. In its common form, that expected return is the risk-free rate plus beta times the market’s return above the risk-free rate. If a fund earned more than that, the difference is positive alpha; if less, alpha is negative. In looser usage, alpha simply means outperformance of a benchmark. More advanced versions also adjust for exposure to other factors, such as company size or value, which can make apparent alpha shrink or disappear.

Active managers sell the promise of positive alpha, but across the market as a whole alpha is a zero-sum game before costs and negative after them: for every investor beating the market, another must be trailing it. Measured alpha is also noisy. A few good years can be luck, and it takes many years of data to separate skill from chance with any confidence. Before crediting a manager with alpha, check that the benchmark really matches the fund’s style and risk.