InvestorQ : With respect to Mutual fund, what does alpha and beta mean?
Mahima Roy made post

With respect to Mutual fund, what does alpha and beta mean?

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Shreya Karn answered.
1 year ago

Alpha and beta are ratios used by financial advisors and investment managers to calculate and analyse the returns of mutual funds.
Alpha is a measure of performance in finance. It is the return made on an investment and hence, gauges the performance of an investment in any asset class against a particular benchmark. The excess or extra return made on an investment as compared with the return made by the benchmark is considered the investment’s alpha.
Alpha is used to indicate under performance or outperformance of a fund. A positive alpha means that fund has outperformed its benchmark index. Correspondingly, a negative alpha would indicate underperformance of the fund.
Please note, it is possible for two funds with same returns to have different alphas because return as well as risk contribute to a fund’s alpha.
In contrast, beta is the measure of volatility or risk in finance. It helps an investor understand how much risk he/she Is willing to take to achieve the stated return. Beta is also the measure of volatility.
The baseline number for beta, in contrast with alpha, is one. A beta of one is an indication that the security's price moves exactly as the market moves. So, if you have a mutual fund with 1.5 beta, then it is more volatile than a mutual fund which has 1 beta. Higher the number, higher the risk.
Alpha and beta are two of the five standard technical risk calculations, with the other three being:
- Standard deviation
- R-squared
- Sharpe ratio

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Nishita Gala answered.
3 weeks ago

Alpha gives a measure of the risk-adjusted performance of your investment. Simply put, it will give you an idea of the excess returns that your invested fund may generate, compared to its benchmark. Alpha is sometimes interpreted as the value that a portfolio manager adds, above and beyond a relevant index's risk/reward profile.

If a fund returns more than what you'd expect given its beta, it has a positive alpha. If a fund returns less than its beta predicts, it has a negative alpha. There is no set formula to generate alpha. This is a combination of the fund manager’s skill set, investment strategies, and capabilities. By taking smart sectoral and stock selection decisions apart from timely investment and disinvestment decisions, the fund manager and his team aim to generate better returns than that of the underlying market or the scheme’s benchmark.

The effectiveness of this endeavor depends on the fund manager’s skills and the fund house’s investment management process. Given how elusive it is to define, generate, and predict alpha, this the reason why alpha-generating funds (active funds) are risky. Active funds, therefore, charge a fund management fee to offer you the extra return potential due to their expertise.