The Morningstar Dictionary: Alpha

A risk-adjusted performance statistic used to evaluate how good a job an investment manager has done.

Wendy Stein 13 July, 2018 | 5:00PM
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Alpha is one of the Modern Portfolio Theory statistics reported by Morningstar. Alpha, along with the other MPT statistics, can help investors assess the risk-return profile of investments. You can find them in the Risk section of a fund or ETF’s Morningstar Report on

Alpha is a risk-adjusted performance statistic that’s used to evaluate how good a job an investment manager has done; that is, how much value he or she has added over and above the return provided by the market over a specific time period.

Alpha is the difference between an investment’s average excess return and the market’s average excess return, adjusted for systematic risk as measured by beta. If you need a refresher on the beta measure, click on the Morningstar Dictionary link below.

Excess return, for both the investment and the benchmark is the difference between total return and the return of a risk-free investment. Excess return is used instead of actual return because it’s assumed that the return of an investment or market benchmark should, at the very least, exceed that of a risk-free investment.

The market is represented by a benchmark index based on the mandate of the investment. For example, a suitable benchmark for a Canadian equity fund that invests in companies listed on the TSX could be the S&P/TSX Composite Index.

Positive alpha for a fund indicates that the fund's manager delivered a better return than what would be predicted based on the fund’s beta. Negative alpha indicates the opposite, that the manager delivered a worse return than expected.

Alpha can be a helpful metric to evaluate how good a job a fund manager has done but there are a few important caveats to keep in mind.

The first has to do with the importance that beta plays in estimating alpha. A meaningful alpha value is completely dependent upon a meaningful beta value because beta is used to estimate an investment’s predicted return. A meaningless beta value translates into a meaningless alpha value.

Second, to ensure an apples-to-apples comparison, you should only compare the alphas of similar investments and in terms of funds, funds in the same category. For example, the alpha of a small cap US equity fund could be compared to that of another small cap US equity fund but not to the alpha of a large cap US equity fund.

Lastly, it’s important to keep perspective. Over any specific time period, an unskilled manager can get lucky and generate positive alpha and a skillful manager can get unlucky and generate negative alpha.

For Morningstar, I’m Wendy Stein.

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About Author

Wendy Stein

Wendy Stein  Wendy Stein is a product manager at Morningstar Canada. She manages products for investment research, portfolio construction and retirement planning. Before joining Morningstar in 2010, she worked as a product manager in the mutual- fund industry for Invesco and Manulife in Canada and Legg Mason in the UK.

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