Meaning —
In the investment world, alpha refers to the returns above the index or benchmark. Every mutual fund has a benchmark that aims to perform better than.
If you’re investing in a large-cap fund, its benchmark would be Sensex or Nifty.
Alpha refers to the returns that your mutual fund was able to give above the returns given by the index. Alpha also represents an asset manager’s performance in guiding a fund into yielding profits in comparison to the benchmark Index.
Alpha is the main reason why people invest in actively managed mutual funds. If there is no alpha, it doesn’t make sense to invest in mutual funds.
Why Alpha is an Important Ratio?
Ratios are an essential tool in determining a fund’s history against different market phases. It also helps produce substantial data to reckon its prospects in the future — growth potential, sustainability, risk factor, etc.
Although these predictions might vary from actual results, it still provides a significant picture to the prospective investor for his/her decision.
The alpha ratio in an instrument is valuable to an investor as it helps him/her to determine whether an asset or fund is worth pursuing depending on the asset manager’s capability to earn profits.
For example, if an asset manager can reap a 10% return on a specific Mutual Fund against a benchmark index of 8%, his/her alpha ratio would be 2. Investors opt to invest as per the alpha ratio in Mutual Funds around 1.5. Note that the alpha ratio in Mutual Funds should be considered based on a mean of previous performance and not just on current data.
Will Explore more on this in the future! Until Next Time Happy Investing Stay Safe.
- Punith G