Alpha

Alpha measures how much your portfolio exceeds the risk-adjusted benchmark. In passive management, the goal is alpha near zero. Index Balance calculates it automatically.

Definition

Alpha (α) measures the performance of a portfolio or fund above (or below) what would be expected given the level of risk taken, generally measured relative to a benchmark. Positive alpha indicates that the investment generated additional return beyond what the market should have produced; negative alpha indicates the opposite.

In passive management, the explicit objective is to have an alpha as close to zero as possible, because any deviation from the index is due to the fund's TER and operational frictions. If an index fund has persistent negative alpha of -0.5%, it is almost always due exactly to its annual fees.

The term is also used colloquially to refer to any informational or analytical edge that allows an active manager to outperform the market. In that context, "seeking alpha" is the goal of active management, although statistically the majority of managers fail to achieve it sustainably.

Practical example

Your portfolio returned 11% in 2023 with a beta of 0.9. If the market (MSCI World) rose 12%, your portfolio would have been expected to rise 10.8% (0.9 × 12%). Since it rose 11%, your alpha was +0.2%. A small but positive difference.