Alpha

Alpha measures the value that a fund manager or investment strategy adds beyond what would be expected given the level of risk taken. If a fund returns 12% while its benchmark returns 10% with comparable risk, the fund generated 2% alpha.

In the Capital Asset Pricing Model (CAPM), alpha represents the y-intercept when plotting an investment's returns against market returns. A positive alpha means the investment consistently earned more than its risk level would predict. Most actively managed funds have negative alpha after fees.

Alpha is the holy grail of active management. Fund managers charge higher fees than index funds specifically because they claim to generate alpha. The overwhelming evidence shows that most managers fail to deliver positive alpha consistently, especially after fees — which is why index investing has grown so dramatically.

Hedge funds, private equity, and quantitative strategies often claim to generate alpha through unique insights, proprietary strategies, or access to opportunities unavailable to retail investors. Evaluating these claims requires understanding whether the "alpha" is truly skill or simply exposure to risk factors not captured by simple benchmarks.

For individual investors, the practical takeaway is that reliable alpha is extremely rare and expensive to access. Most investors are better served by capturing beta (market returns) through low-cost index funds rather than paying high fees in search of alpha.