Definition of Alpha
In investing, alpha is the excess return generated by a fund (or portfolio manager) above and beyond the returns of its benchmark index. It represents the value added (or subtracted) by the fund manager's stock selection and timing decisions, after accounting for market movements.
A positive alpha of 2 means the fund outperformed its benchmark by 2% per year. A negative alpha of −1 means the fund underperformed by 1%. Alpha is a key measure of active management skill — a fund consistently generating positive alpha after fees is genuinely adding value; one with negative alpha is destroying it compared to simply buying an index fund.
Important caveat: alpha is calculated using historical data and can be misleading over short periods. Always evaluate alpha over multiple market cycles (5+ years) and net of all fees. Most actively managed funds fail to sustain positive alpha over long periods, which is why index funds are recommended as a core portfolio holding.