One concept that is on the lips of every investment analyst, pension fund, or mutual fund manager these days is ‘alpha’. It’s not a new concept, but for some reason it’s become the buzz word of the month on Wall Street. So what the heck is it?
Alpha measures by how much someone can beat the market. But which market? Beating the S&P is quite a bit different from beating the Nasdaq, or the Turkish stock exchange. So we say that someone is providing ‘alpha’ in excess of their benchmark index, which is hilariously called ‘excess returns’ (like any investor would say “Oh, that’s too much, I made excessive money on this investment, take some back”).
Alpha is one of the concepts that point out the big difference between the average person on the street and professional investors. If the S&P 500 is down 20%, and their fund is down 15% (and the S&P 500 is an appropriate index) they would crow about how they provided 500 basis points (a basis point is 1/100 of a percent) of alpha. The average person on the street would say “But I was down 15%, what’s so great about that?”. Alpha is a measure of relative, not absolute performance. Keep that in mind when that mutual fund sales guy starts to make your eyes glaze over with his patter about ‘alpha’.