alpha in mutual fund

Alpha in a mutual fund is a measure of the excess returns that a fund generates over its benchmark index, after adjusting for risk. It is a measure of the fund manager's skill in picking stocks and managing the fund.

Alpha is calculated using the following formula:
Alpha = (Fund return - Benchmark return) / (Benchmark standard deviation)

Let’s take an example of a portfolio to understand the alpha calculation. Suppose the actual return earned by the portfolio is 20%, and the beta is 1.1. 10% is the risk-free rate of return, and 15% is the benchmark index return.

Alpha would be calculated as follows:
Alpha = 0.20 – ( 0.10 + 1.1 (0.15 – 0.10))
= 0.20 – 0.155 = 0.045 = 4.5%

If a fund has a positive alpha, it means that it has outperformed its benchmark index. A negative alpha means that the fund has underperformed its benchmark index.
A high alpha indicates that the fund manager is able to generate returns that are higher than what would be expected given the risk of the fund. This is a good thing for investors, as it means that they are getting more value for their money.

However, it is important to note that alpha is not a guarantee of future performance. Fund managers can have good alphas for a period of time, but they can also underperform their benchmarks in the future.