Alpha

Alpha is a measure of a fund’s over- or underperformance in comparison to the benchmark of the fund. It is calculated by taking the funds return and subtracting the benchmark return multiplied by the beta of the fund. Alpha represents the extra value the manager’s activities have contributed, the greater the alpha, the greater the outperformance.

If the benchmark produced a return of zero an alpha of 5 would indicate that the fund had returned 5%, this is however only true in the instance where the benchmark has zero return.

Assuming that a strong rsquared correlation exists, the beta will show how volatile the fund is compared to its benchmark and thus indicate how much extra risk the manager has taken on in order to achieve higher alpha performance. Negative alpha in conjunction with beta of 1 is an indication of poor performance, meaning that managers are subjecting funds to volatility that is higher than that of the benchmark while achieving returns that are lower than the benchmark attained. So, if alpha indicates better/worse performance compared with the index, beta would show higher/lower risk.