Alpha and Beta
Suzanne Arnold is Chief Investment Officer at the Greek Fund, a successful fund of funds. At an investment committee meeting, she comments on the performance of a convertible arbitrage fund named MAK Fund: “MAK generated an alpha of 8% last year and 10% two years ago. I think we can expect an alpha of 4% next year.”
The fund of funds’ portfolio manager debates the point: “MAK Fund takes positions in convertible bonds with high credit risk. I think that MAK's alpha during the last two years was really beta.” Arnold replies: “But MAK is delta-hedged. And even though the fund is long gamma, is there really any beta in being long gamma?”
6.1 OVERVIEW OF BETA AND ALPHA
This discussion illustrates how Greek letters are often used in investments to represent key concepts. For example, delta and gamma are important risk measures in options, which are used in both traditional and alternative investment analysis.
This chapter focuses on alpha and beta, two critical concepts in the area of investments and alternative investments, in particular. In a nutshell, alpha represents or measures superior return performance, and beta represents or measures systematic risk. Beta and, to a much lesser extent, alpha were discussed in Chapter 4 on risk, return, benchmarking, and asset pricing models. The purpose of this chapter is to explore their meanings and nuances.
In the CAPM (capital asset pricing model), the concept of beta is precisely identified: Each asset ...