Alpha

Alpha is used to measure the value a fund manager adds. If a fund simply follows the market, its returns will rise and fall with the market. Alpha captures the extra return, positive or negative, beyond what the market exposure alone would explain.

In a simple version, alpha is the fund's return minus the benchmark's return. In a more refined version, the expected return is calculated using the fund's beta through the Capital Asset Pricing Model, and alpha is the difference between the actual and expected return.

For example, a fund with a beta of 1.0 earns 12% in a year when its expected return, based on market performance and its risk, is 9%. Its alpha is 3 percentage points. If it had earned 7%, its alpha would be −2 percentage points.

Positive alpha suggests the manager added value through skill, such as selecting securities or timing decisions. Negative alpha suggests the manager underperformed, possibly after fees.

Research shows that consistently generating positive alpha after fees is difficult, and many active funds fail to do so over long periods, which is one reason for the growth of low-cost index investing.