Alpha beta investment definition

Alpha is a measure of the active return on an investmentthe performance alpha beta investment definition that investment compared with a suitable market index. Alpha, along with betais one of two key coefficients in the capital asset pricing model used in modern portfolio theory and is closely related to other important quantities such as standard deviationR-squared and the Sharpe ratio.

In modern financial markets, where index funds are widely available for purchase, alpha is commonly used alpha beta investment definition judge the performance of mutual funds and similar investments. As these funds include various fees normally expressed in percent alpha beta investment definition, the fund has to maintain an alpha greater than its fees in order to provide positive gains compared with an index fund. Historically, the vast majority alpha beta investment definition traditional funds have had negative alphas, which has led to a flight of capital to index funds and non-traditional hedge funds.

It is also possible to analyze a portfolio of investments and calculate a theoretical performance, most commonly using the capital asset pricing model CAPM. Returns on that portfolio can be compared with the theoretical returns, in which case the measure is known as Jensen's alpha. This is useful for non-traditional or highly focused funds, where a single stock index might not be representative of the investment's holdings.

It is the intercept of the security characteristic line SCLthat is, the coefficient of the constant in a market model regression. It can be shown that in an efficient marketthe expected value of the alpha coefficient is zero.

Therefore, the alpha coefficient indicates how an investment has performed after accounting for the risk it involved:. In this context, because returns alpha beta investment definition being compared with the theoretical return of CAPM and not to a market index, it would be more accurate to use the term of Jensen's alpha.

A belief in efficient markets spawned the creation of market capitalization weighted index funds that seek to replicate the performance of investing in an entire market in the weights that each of the equity alpha beta investment definition comprises in the overall market. In fact, to many investors, [ citation needed ] this phenomenon created alpha beta investment definition new standard of performance that must be matched: The name for the additional return above the expected return of the beta adjusted return of the market is called "Alpha".

Besides an investment manager simply making more money than a passive strategy, there is another issue: The passive strategy appeared to generate the market-beating return over periods of 10 years or more. This alpha beta investment definition may be risky for those who feel they might need to withdraw their money before a year holding period, for example.

Thus investment managers who employ a strategy which is less likely to lose money in a particular year are often chosen by those investors who feel that they might need to withdraw their money sooner. Investors can use both alpha and beta to judge a manager's performance. If the manager has had a high alpha, but also a high beta, investors might not find that acceptable, because of the chance they might have to withdraw their money when the investment is doing poorly.

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