Alpha
Alpha measures excess return generated relative to a benchmark or risk-adjusted expected return — the value added by active management.
Concept map
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Definition
Alpha measures excess return generated relative to a benchmark or risk-adjusted expected return — the value added by active management.
Use case
Used in portfolio management workflows, analysis, and technical interviews.
Judgment check
Useful only when the assumptions and inputs behind the metric are understood.
Deep dive
How to think about Alpha
Alpha = Actual Return - Expected Return (per CAPM or other model). Positive alpha indicates outperformance; negative indicates underperformance. In efficient markets, alpha is theoretically zero (no free lunch). The quest for alpha drives active management fees, though most managers fail to consistently generate positive alpha after fees.
Example: A fund returns 18% while its benchmark (S&P 500) returns 15%. The fund has beta 1.1, risk-free rate 5%. CAPM expected return = 5% + 1.1 × (15% - 5%) = 16%. Alpha = 18% - 16% = 2% (200 basis points of outperformance).