With that said, LPs of actively managed funds that prioritize high returns will gauge the investment acumen of a potential investment firm by tracking their historical alpha. market hedge) – for their limited partners (LPs) to have an incentive to provide funding. Here, assuming the alpha is equal to zero, that would imply that the portfolio is tracking the broader market.Īctive investment firms’ offerings should provide a benefit – either above-market returns or more stability (i.e. ETFs) that track the overall market performance. If not, investor capital would be better off being allocated to passive index investments (e.g. In other words, beta is the minimum return for investors – or more specifically, the hurdle that “active” investors like hedge funds must exceed. Beta in Investment Theoryīeta, in contrast to the concept of alpha, measures the risk/returns of the broader market, above which investors attempt to achieve returns. the cost of equity – and the portfolio returns is known as “Jensen’s Alpha”. Alpha = Portfolio Return – Benchmark ReturnĪlternatively, the difference between the expected return from the capital asset pricing model (CAPM) – i.e.stocks, bonds) and a benchmark return (e.g. In general, the formula for alpha can be explained as the difference between the return of an investment portfolio (e.g. Most often, the benchmark used to compare returns against is the S&P 500 market index. If an investment strategy has generated alpha, the investor has “beat the market” with abnormal returns above that of the broader market. Alpha (α) in the context of finance is a term defined as the “excess returns” from a portfolio of investments, typically comprised of equities.Īlpha refers to the incremental return achieved by fund managers in excess of benchmark returns.
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