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What Is Alpha?Alpha is risk adjusted. It's coefficient is one of the parameters of the capital asset pricing model and can be used to calculate whether an investment manager has added value - or created economic value as an economist would say. An average investor cannot get above market performance say the theorists, because an average investor cannot know as much - or more - than the market itself. This plays into the hands of those who prefer to track an index rather than to actively invest. This is the realm of the Efficient Market Hypothesis. Efficient market hypothesis informs us that market prices take into account all available information at the time. Clearly this is more information than any individual investor could hope to take into account. In the modern world, all information relating to an investment is expected to be in the public domain as soon as possible and that no investor should have an unfair advantage. However, no system is perfect and clearly a director or employee of a company is likely to know more than the most astute active investor. The theory presumes that any extra value an investor sees in a share is incorrect when compared to the price actually set by the market. Therefore, EMH tells us that it is impossible to outperform the market. Just ask Warren Buffett or Peter Lynch their thoughts about that... In contrast, the financial services and investment industries make it appear as though you almost can’t help beating it. Key features documents will explain how an investment can 'go down as well as up' but the rest of the glossy brochure collection is usually committed to explaining just how fast an investment has risen. This plays on human nature rather than an investment theory. Sales copy for an investment fund rarely covers investment theories which by nature can put most people to sleep.
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