Alpha is one of the Modern Portfolio Theory statistics reported by Morningstar. Alpha, along with the other MPT statistics, can help investors assess the risk-return profile of investments. You can find them in the Risk section of a fund or ETF’s Morningstar Report on Morningstar.ca.
Alpha is a risk-adjusted performance statistic that’s used to evaluate how good a job an investment manager has done; that is, how much value he or she has added over and above the return provided by the market over a specific time period.
Alpha is the difference between an investment’s average excess return and the market’s average excess return, adjusted for systematic risk as measured by beta. If you need a refresher on the beta measure, click on the Morningstar Dictionary link below.
Excess return, for both the investment and the
The market is represented by a benchmark index based on the mandate of the investment. For example, a suitable benchmark for a Canadian equity fund that invests in companies listed on the TSX could be the S&P/TSX Composite Index.
Positive alpha for a fund indicates that the fund's manager delivered a better return than what would be predicted based on the fund’s beta.
Alpha can be a helpful metric to evaluate how good a job a fund manager has done but there are a few important caveats to keep in mind.
The first has to do with the importance that beta plays in estimating alpha. A meaningful alpha value is completely dependent upon a meaningful beta value because
Second, to ensure an apples-to-apples comparison, you should only compare the alphas of similar investments and in terms of funds, funds in the same category. For example, the alpha of a small cap US equity fund could be compared to that of another small cap US equity fund but not to the alpha of a
Lastly, it’s important to keep perspective. Over any specific time period, an unskilled manager can get lucky and generate positive alpha and a skillful manager can get unlucky and generate negative alpha.
For Morningstar, I’m Wendy Stein.
