Alpha | Alternative Investment Portfolios | Hedge Funds

Alpha | Investment Portfolios

Alpha | Alternative Investment Portfolios

(1) A measure of a portfolio's return in excess of the market return, after both have been adjusted for risk. It is also a measure of the manager's contribution to performance due to security selection. A positive alpha indicates that the portfolio outperformed the market on a risk-adjusted basis, and a negative alpha indicates the portfolio did worse than the market.

In Russell Performance Universes (RPU), alpha is calculated as follows:

Where	Equals
	Alpha
Ryi	Portfolio excess return (portfolio return minus risk free proxy return)
n	Number of observations
	Beta; sensitivity of a portfolio's rate of return to the market
Rxi	Market excess return (market proxy return minus risk-free proxy)

(2) In the context of a mutual fund, alpha is the premium the fund would be expected to earn if the market rate of return were equal to the risk-free rate (e.g., T-bill rate) -- that is a premium of zero for the market rate of return. A positive alpha value indicates that the fund has earned on average a premium above that expected for the market at the same level of risk (variability) as the fund. A negative alpha indicates that the fund averaged less than that expected for the market at the fund's risk level.

(3) A measure of selection risk (also known as residual risk) of a mutual fund in relation to the market. A positive alpha is the extra return awarded to the investor for taking a risk, instead of accepting the market return. Because of this, alpha is sometimes used as a performance indicator of mutual funds.

For example, an alpha of 0.4 means the fund outperformed the market-based return estimate by 0.4%. An alpha of -0.6 means a fund's monthly return was 0.6% less than would have been predicted from the change in the market alone.

(4) Alpha is also known as the average differential return of a mutual fund. The average differential return is the difference between the average return on the fund and a point on the market line corresponding to the fund's beta coefficient, where the market line is determined by the average excess returns for the market and the market portfolio's beta.

(5) In the context of a Jensen index, alpha represents the performance of a portfolio that diverges from the portfolio's beta. In this context alpha can also be used as a measure of the portfolio manager's performance.

In Russell Style Classification (RSC), alpha is calculated as follows:

Where	Equals
	Alpha
_ x	Benchmark return
_ y	Portfolio return
	Beta

For over 1,000 additional terms and definitions please see our Investment Glossary Guide.

Related to Alpha | Alternative Investment Portfolios:

• Geographical Hedge Fund Guides
• Hedge Fund Employment Guide
• Financial Certification
• Investment Book
• Hedge Fund Terms and Definitions

Tags: Alpha | Alternative Investment Portfolios, alpha, alpha portfolio, what is alpha, define alpha, alpha definition, alpha investing theory, alpha beta, what is alpha and beta