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What is ‘alpha’?

In finance, traders and investors will typically refer to how much ‘alpha’ they can get. This is the margin by which a trader can beat the market....

14 April 2021

Martin Cozens

In finance, traders and investors will typically refer to how much ‘alpha’ they can get. This is the margin by which a trader can beat the market. Alpha is essentially a gauge for returns: the more the better. If a market benchmark (beta) is 2% and an investor is getting 5% then they are beating the market and gaining 3% alpha.

All investors will seek ‘alpha’ but it can be an illusory concept because the ‘benchmark’ it beats could simply be a fixed-income return rather than an accurate market tracker. Likewise, a broker might say they have beaten a market returning 3% with returns of 5% giving 2% alpha but they might charge fees of 3% meaning your overall return is 2% which is actually an alpha reading of -1%.

While lots of alpha might mean great returns, it could also indicate risk and volatility. Most investment portfolios will have safe assets such as gold to offset risk. If volatility means other assets lose value to a market downturn, gold can often gain – beating the market with alpha of its own. Between 2000 and 2011 gold rose from $250 to $1900, showing significant alpha while also being one of the safest assets.

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