Alpha in investment is a strategy to beat the market or its edge. It is commonly called an excess return or abnormal rate of return. In finance it is a performance measurement that indicates strategy, trader, or portfolio manager managed to beat the market return in a particular period of time. In an investment it is an active return gauging the performance against benchmark representing market’s movement. Thus, alpha could be positive or negative, it is an active investing result. In beta on the other hand, people could earn from passive index investing. The active portfolio managers diversify their portfolios through alpha. They use this in order to push unsystematic risk.
Alpha helps individual investors to know how a stock or fund performs in relation to its peers and the market. Professional portfolio managers utilize alpha for the rate of return exceeding the model’s prediction or comes short of it. Commonly they project the potential returns in the investment portfolio by using capital asset pricing model (CAPM). In most of the cases, it is a higher bar. The alpha portfolio could show as worse as -2%. It could happen when CAPM analysis indication requires 5% earning based on risk and other conditions. But instead, it only earned 3%.
In order to balance risk, portfolio managers generate a higher alpha by diversification. This is because alpha signifies portfolio relative to a benchmark performance. It is the value that a portfolio manager builds from a fund’s return. Zero is alpha’s baseline number. It shows that the portfolio or fund tracks well with the benchmark index. In this scenario, the investment manager is in the position of neither gaining nor losing.