Alpha (α)

Alpha is the measurement of the investee’s returns. We, as an investor should know positive alpha is good. Lets illustrate, for a moment suppose, the benchmark index is Sensex which is giving return at 20% on the other hand your stock is giving you the return of 22%. It means your portfolio has positive alpha.

It is very difficult to maintain the positive alpha for the longer period. As we all know there are many determinants that affect the market which are uncontrollable. That’s why I suggest to just forget about ALPHA. We would love to find positive alpha, but are more concerned about avoiding the negative alpha. To earn the return the market has generated earlier, investors need to capture full beta of the market.

If we go in a bit of technicality, Alpha simply describes the part of return is due to choosing the right investment in stock class.

Mathematical Expression:

Alpha (α): R_p- CAPM

Where; CAPM=  R_f+(R_m-R_f)*β)

Hence;

Alpha (α): Rp- {R_f+(R_m-R_f)*β)}

Where;

R_p= Return on Portfolio

R_m= Market Return

R_f = Risk free Rate
Now lets synthesize the Expression.
Suppose our return on portfolio is 20% on the other hand CAPM or Return on equity Is 18%, there is positive alpha. Hence we know, even we are earning 18% return on the equity but on  a personal note, when we look at our portfolio we find that due to better investing decision or portfolio is giving us 2% extra return over the asset class.


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