Corporate Finance - Alpha vs. Active Return

This video discusses the difference between alpha and the active return of a portfolio. The active return of a portfolio is the difference between the portfolio's actual return and the return of the market portfolio. For example, if the fund manager actively manages a portfolio so that it has a return of 24%, and the S&P 500 has a return of 11% during the same time period, the active return of the fund manager's portfolio would be 13%. This does not account, however, for the systematic risk of the portfolio. Alpha is different from the active return because alpha adjusts for the systematic risk of the portfolio. Alpha is the difference between the portfolio's actual return and the return that was expected based on the portfolio's systematic risk. For example, let's say that the actual return of the portfolio is 24%, the market return is 11%, the risk-free rate is 1%, and the beta of the portfolio is 2.00. The alpha of the portfolio is therefore 3%, which was calculated as follows: alpha = [24% - 1%] - [2* (11% - 1%)] = 3% Thus, while the active return was 13%, the alpha was only 3%. The alpha was lower than the active return because the portfolio has a beta of higher than one. This means that the portfolio has more systematic risk than the market portfolio. Thus, if the market portfolio increases, we would expect the portfolio to experience an even higher increase because it has more risk. Alpha adjusts for this higher level of systematic risk; after accounting for systematic risk, the return of the portfolio is 3% higher than the expected return according to the Capital Asset Pricing Model.— Edspira is the creation of Michael McLaughlin, an award-winning professor who went from teenage homelessness to a PhD. Edspira’s mission is to make a high-quality business education freely available to the world. — SUBSCRIBE FOR A FREE 53-PAGE GUIDE TO THE FINANCIAL STATEMENTS, PLUS: • A 23-PAGE GUIDE TO MANAGERIAL ACCOUNTING • A 44-PAGE GUIDE TO U.S. TAXATION • A 75-PAGE GUIDE TO FINANCIAL STATEMENT ANALYSIS • MANY MORE FREE PDF GUIDES AND SPREADSHEETS * http://eepurl.com/dIaa5z — SUPPORT EDSPIRA ON PATREON *https://www.patreon.com/prof_mclaughlin — GET CERTIFIED IN FINANCIAL STATEMENT ANALYSIS, IFRS 16, AND ASSET-LIABILITY MANAGEMENT * https://edspira.thinkific.com — LISTEN TO THE SCHEME PODCAST * Apple Podcasts: https://podcasts.apple.com/us/podcast/scheme/id1522352725 * Spotify: https://open.spotify.com/show/4WaNTqVFxISHlgcSWNT1kc * Website: https://www.edspira.com/podcast-2/ — GET TAX TIPS ON TIKTOK * https://www.tiktok.com/@prof_mclaughlin — ACCESS INDEX OF VIDEOS * https://www.edspira.com/index — CONNECT WITH EDSPIRA * Facebook: https://www.facebook.com/Edspira * Instagram: https://www.instagram.com/edspiradotcom * LinkedIn: https://www.linkedin.com/company/edspira — CONNECT WITH MICHAEL * Twitter: https://www.twitter.com/Prof_McLaughlin * LinkedIn: https://www.linkedin.com/in/prof-michael-mclaughlin — ABOUT EDSPIRA AND ITS CREATOR * https://www.edspira.com/about/ * https://michaelmclaughlin.com