Jensen’s Alpha is a risk-adjusted performance benchmark that tells you how by much the returns of an actively managed portfolio are above or below market returns.
Originating in the late 1960s, Jensen’s Alpha (often abbreviated to Alpha) was developed to evaluate the skill of active fund managers in stock picking.
- A positive Alpha means that a portfolio has beaten the market, while a negative value indicates underperformance
- A fund manager with a negative alpha and a beta greater than one has added risk to the portfolio but has poorer performance than the market
Careful stock picking and financial engineering means that investors can add alpha to a portfolio without adversely affecting beta.
According to the Capital Asset Pricing Model, Alpha is defined by this equation
alpha = rs – [rf + β (rb – rf)]
where rs is the expected portfolio return, rf is the risk-free rate, β is the portfolio beta, and rb is the market return. Beta describes the volatility of the portfolio with respect to that of the wider market, and is calculated with this equation
Calculate Alpha with Excel
Thse steps describe how you can calculate Alpha with Excel (there’s a link to download the tutorial spreadsheet at the bottom). The screegrabs describe the formulae used in the spreadsheet.
Step 1: Put the returns of your portfolio and the benchmark index into Excel, and calculate the average returns