Definition Of Alpha

Alpha (α) is popularly used in investing to explain an investment strategy’s ability to gain high level of profit. Alpha is therefore also generally known as excess return or the abnormal rate of return comparing to a benchmark, when adjusted for risk.

We also can say, alpha is the excess return on an investment that is not a result of a general movement of the security market. Hence, a zero alpha would indicate that the portfolio or fund is going perfectly with the benchmark index and that the manager has not added or lost any additional value in the market.

# APPLICATION OF ALPHA IN INVESTMENT

Alpha is used in finance as a measure of performance, indicating when a strategy, trader, or portfolio manager has managed to beat the market return or other benchmark over some period. Alpha, often considered the active return on an investment, gauges the performance of an investment against a market index or benchmark that is considered to represent the market’s movement as a whole.

The excess return of an investment relative to the return of a benchmark index is the investment’s alpha. Alpha may be positive or negative and is the result of active investing. Beta, on the other hand, can be earned through passive index investing.

Active portfolio managers seek to generate alpha in diversified portfolios, with diversification intended to eliminate unsystematic risk. Because alpha represents the performance of a portfolio relative to a benchmark, it is often considered to represent the value that a portfolio manager adds to or subtracts from a fund’s return.