Alpha

What is Alpha? — Definition

Alpha measures how much better (or worse) an investment performs compared to a relevant benchmark, after adjusting for risk. An alpha of +3% means the investment returned 3 percentage points more than the benchmark. A negative alpha means underperformance. It is the key metric for judging whether active investing adds value over simply buying an index fund.

Alpha is closely linked to beta (market risk). A fund that beats the market simply by taking on more risk hasn't generated true alpha — it's just accepted more volatility. True alpha is performance that can't be explained by market exposure alone.

Example

If the S&P 500 returned 12% in a year and your portfolio returned 17%, you generated approximately 5% alpha. But if your portfolio was twice as volatile as the market, risk-adjusted alpha would be much lower or even negative.

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