What is Alpha in Mutual Funds ? Higher or Lower Alpha is good ?
In mutual funds, Alpha measures the ability of a fund manager or investment strategy to beat the market. It indicates the excess return a portfolio generates over its benchmark. A positive alpha means the fund has outperformed its benchmark, while a negative alpha means it has underperformed.
How Alpha Works
- Calculation: Alpha is calculated by comparing the actual return of the fund to the expected return, which is typically based on the market’s performance and adjusted for risk.
- Interpretation:
- Positive Alpha: Indicates that the fund has outperformed the market or benchmark. For instance, an alpha of +1 means the fund beat the market by 1%.
- Negative Alpha: Indicates underperformance. An alpha of -1 means the fund fell short of the market by 1%.
Why Alpha Matters
Alpha helps investors assess if a fund manager’s skill is adding value compared to a passive strategy. It’s a critical metric for those looking to invest in actively managed funds, as a high alpha can signal good management and potential for higher returns over time.
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