The term “alpha” may also refer to the excess return, active return, or abnormal rate of return. It is a metric that illustrates when an investment outperforms the market, an index, or an appropriate benchmark over a given time frame. Or when the investment outperforms the market. The alpha might be either positive or negative, depending on how close to the market it is.
The terms alpha and beta are sometimes used interchangeably when discussing how to compare and analyze portfolio performance. Beta measures a portfolio’s historical volatility, or risk, in relation to the larger market, whereas alpha measures a portfolio’s return.
It has its pros and cons. So let’s have a look at them.
Pros: Alpha can provide fund managers with a broad understanding of how their portfolios compare to the market as a whole. Alpha can be an appropriate tool in trading and investing for determining market entry and exit opportunities.
Cons: As it is only appropriate for stock market investments, using alpha as a way to measure returns has several drawbacks. For example, it cannot be used to compare other investment portfolios or asset classes.
