Definition
Alpha represents the value-added return that cannot be explained by market or factor exposures. Positive alpha indicates the manager outperformed their benchmark on a risk-adjusted basis. In modern factor-based analysis, alpha is the return remaining after accounting for exposure to market, size, value, momentum, and other systematic factors.
lightbulb Example
A hedge fund returns 18% when its factor exposures explain 12% of expected return. Alpha = 6%—the return attributable to the manager's unique insights, timing, or stock selection.
verified_user Key Points
- Return not explained by systematic risk factors
- True alpha is rare and difficult to sustain
- Factor exposure can masquerade as alpha
- Net-of-fee alpha is what matters to investors