What Is Alpha?
Alpha is the return a strategy or portfolio earns above what could be explained by exposure to the market (beta). A fund that returns 12% in a year when the S&P returned 10% with the same risk profile has 2% alpha — that's the manager's skill, separated from market exposure.
True alpha is hard to generate. Active fund managers, in aggregate, underperform their benchmarks net of fees. Persistent alpha — generating it consistently over multi-year periods — is exceptionally rare. Most apparent alpha turns out to be hidden beta (factor exposure) or short-period luck.
For individual traders, alpha is what's left after subtracting your strategy's beta exposure. If your portfolio is 100% long stocks and the market goes up 20%, you weren't generating alpha — you were just along for the ride. Real alpha shows up in your performance during market drawdowns or sideways periods.
Related terms
- Beta — Sensitivity of an asset's returns to overall market returns.
- Sharpe Ratio — Risk-adjusted return — the excess return per unit of volatility.
- Benchmark
- Risk Management — The systematic process of identifying and controlling exposure to losses.