DEFINITION:
Alpha measures an investment’s performance compared to a benchmark index, indicating the extra value or underperformance generated by a manager’s decisions.
WHEN AND WHY IT’S USED:
Alpha is used to determine whether an investment or a portfolio manager has added value beyond what the market would typically provide. It is a key performance indicator, especially for actively managed funds, where the goal is to beat the market benchmark. Investors refer to alpha to evaluate the effectiveness of investment strategies over time.
IMPORTANCE IN COMMUNICATION:
Discussing alpha with your advisor is essential for understanding how much of your investment return is attributable to market movements versus active management. It helps you gauge the effectiveness of the strategies being employed and provides a basis for comparing performance over time. This clarity can reinforce your confidence in the chosen investment approach.
Open communication about alpha also allows you to discuss potential adjustments to your portfolio. If the alpha is consistently low or negative, it might prompt a review of management strategies or even lead to considering alternative investment approaches. This dialogue ensures that performance expectations remain realistic and aligned with your long-term objectives.
EXAMPLES IN CONVERSATION:
“What alpha are we targeting in my portfolio?”
“How has our portfolio’s alpha changed over time?”