Alpha (which is also known as the alpha coefficient) is a way of analysing the value that an active fund manager – ie, one who tries to beat his benchmark rather than just track it – adds to his or her fund.
Alpha measures the rate of return made by a portfolio relative to the return on that benchmark after adjusting for any added investment risk (which is measured by beta – see next page). For example, suppose a fund achieves a 30% return while its benchmark rises by 8%. But say the fund is three times more volatile than the benchmark (in other words, it has a beta of three). That would make the fund’s alpha 30% – (3 x 8%), ie, 6%.
This means the fund has returned 6% more than you would expect, once allowance has been made for the additional risk that the portfolio manager has taken on.