Alpha is the part of your return that market exposure cannot explain. If your portfolio has a beta of 1.2 and the market gained 10%, beta alone should have delivered 12% — anything above that is alpha, anything below is negative alpha.
It is the cleanest single measure of whether active decisions — stock picking, sizing, timing — added value over simply holding an index fund at the same risk.
Computed since inception against SPY with the risk-free rate taken as 0, in percentage points per year.
A portfolio with a 14% CAGR and beta 1.1 while SPY compounded 10% has alpha of about +3 pp per year:
The same 14% CAGR with beta 1.5 would mean −1 pp — the extra return was just extra market risk, not skill.
Reference bands, in percentage points per year:
| Alpha | Reading |
|---|---|
| < −2 | consistently trailing the market risk-adjusted — an index fund would be cheaper |
| −2…0 | roughly market performance (most active investors land here or below) |
| 0…+2 | beating the market — better than most funds |
| +2…+5 | very good; strong-manager territory |
| > +5 | exceptional; almost never sustained over 10+ years |
Read alpha together with tracking error: high tracking error with positive alpha means the active bets are paying; with negative alpha it is risk without reward.
Alpha is the fairest scorecard on short-to-medium horizons where CAGR is dominated by entry timing, and the deciding number in the “active picking vs index fund” question.
Noisy on short histories — a couple of lucky positions can print +10 pp without any repeatable skill. Requires at least 3 overlapping months with the benchmark. With risk-free assumed 0 it runs slightly high versus textbook Jensen’s alpha.