June 23, 2016

The Trouble with Alpha: Part I

Investors equate “alpha” to outperformance.  A high alpha fund presumably delivers substantial excess returns relative to its benchmark. True alpha is short-hand for manager skill.  Statistically, alpha simply is the result of a linear regression between two return streams. The regression finds the straight line (ordinary least squares) that best fits the time series. Visually, beta is the slope of the line and alpha is where it crosses the vertical axis. The calculation was designed to uncover managers who outperform simply by taking on more risk. A manager who leverages to outperform the S&P in an up year will show …

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