Alpha, beta, and investment performance

Barry Ritholtz of Fusion IQ has an excellent explanation of Beta and Alpha on his overwhelmingly useful blog, The Big Picture.

Alpha (α) and Beta (ß) are found in most investment performance analyses, whether individual issues (a single stock or bond), mutual funds, ETFs, or fancy investments like hedge funds. If you read much investment news online, you have probably encountered Seeking Alpha, which aggregates the writings of brokers and analysts.

Beta measures how closely your investments perform relative to your benchmark. If you were to do nothing else but buy that benchmark index (i.e., S&P500), you will have captured Beta (for these purposes, I am ignoring volatility).

…Alpha is the risk-adjusted return of active management for any investment. The goal of active management is through a combination of stock/sector selection, market timing, hedging, leverage, etc. is to beat the market. This can be described as generating Alpha.

To oversimplify: Alpha is a measure of out-performance over Beta.

It’s a worthwhile read if you want to understand what you are reading on Yahoo or Google Finance, or in your broker’s materials. Or, you can pay me to understand it for you and get on with the more interesting parts of your life.

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