What is Alpha

What is alpha?

Alpha is a measure of the returns on investment, which may be either more or less than that of the benchmark index on an exchange.

What is a good alpha?

When a fund manager outperforms the market, it is a good alpha and vice versa. Generally, a positive alpha is a good alpha. For ex:- If alpha is 2.5%, this means that the investment has generated additional returns of 2.5% as compared to the benchmark index.

What is the formula for calculating alpha?

Alpha =Rp- Bp*Rb

A risk-adjusted calculation of excess returns, which will be referred to as alpha, incorporates the risk-adjusted returns of the benchmark with the following formula:-

Where Rp is returns on the portfolio

Bp is the Beta or risk of the portfolio

Rb is the returns on the benchmark

What is Jensen’s Alpha?

Here the alpha is calculated as the difference between the return predicted by the Capital Asset Pricing Model and the actual returns. A positive Jensen alpha indicates that the portfolio can beat the market, thereby generating higher returns. The formula for Jensen’s Alpha is:-

α = Rp – [Rf + (Rm – Rf) β]

Where Rp = Returns on the portfolio

             Rf = Risk free returns

          Rm = Market returns

             β  = Beta

Beta of a portfolio
Source: Tavaga Research

Alpha Vs Beta

Quite a lot of times, Alpha and Beta are considered to be the same, but however, it is not the case. While Alpha measures the return on investment taking into consideration the risk-adjusted expected returns, Beta measures the volatility of a stock as compared to the market Index. It is a measure of Risk.