Risk
Alpha
Return above what the risk taken would ordinarily have earned — the part attributable to skill.
How it works
Alpha is what is left after stripping out the return explained by market exposure. Beating the market by taking more market risk is not alpha; it is beta with a bigger number.
Genuine, persistent alpha is rare and hard to distinguish from luck over any short period. Distinguishing them reliably takes far more data than most track records contain.
Where it misleads people
Alpha measured against the wrong benchmark is meaningless. A small-cap fund compared with a large-cap index will show "alpha" that is simply the size factor.
Formula
Alpha = actual return − [risk-free rate + beta × (market return − risk-free rate)]Worked example
A fund returns 12% with a beta of 1.2, while the market returns 10% and cash pays 2%. Expected return = 2 + 1.2 × 8 = 11.6%. Alpha ≈ 0.4%.
Related terms
- BetaHow much an investment tends to move when the market moves, with 1.0 meaning it moves in line.
- Capital asset pricing modelA model saying an asset’s expected return depends on the risk-free rate plus its market risk.
- BenchmarkThe index or reference portfolio you measure yourself against, to see whether your decisions added anything.
- Factor investingBuilding portfolios around characteristics that have historically explained returns.
- Active managementChoosing holdings deliberately in an attempt to beat a benchmark.
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Educational reference only. Nothing here is investment advice or a recommendation to buy or sell anything, and tax treatment depends on your own circumstances and the country you are in.