Returns made on investments in Mutual Funds is an important variable that investors look at. An investment being profitable or unprofitable is judged by tracking the returns of the particular scheme. However, can returns of a scheme clearly capture the advantages or disadvantages of staying invested in a scheme? Is there a variable amongst the variables available that can capture to a certain extent the nuances associated with understanding returns? If there is, it is alpha.

1. What do you mean by alpha?

Alpha in mutual funds is the barometer that helps in understanding the soundness of one’s investments in a particular scheme. Schemes have an index against which their performance is benchmarked. For example, a large-cap scheme could be benchmarked against the BSE 100 index. To understand this better let us consider two scenarios.

In the first case, let us assume a scheme has delivered 20% returns and the benchmark BSE 100 delivers 15% returns in a year. In the second case, let us assume a scheme has delivered 15% returns and the benchmark BSE 100 delivers 20% returns.

Thus it can be seen that in the first case the scheme has delivered 5% higher returns than the benchmark. The excess return of 5% that the scheme has generated is the alpha. Similarly, it can be seen in the second case that the scheme has delivered lesser than the benchmark returns. This can happen due to various reasons one of which could be that the fund manager was not able to invest in stocks that could have boosted the returns.Thus, alpha is the excess return generated by a scheme that is over and above the benchmark index.




2. How does one understand alpha and beta?

Volatility is an important factor that investors need to bear in mind when understanding returns. An aspect of volatility that is associated with the scheme shows how volatile the schemes portfolio is with respect to its average. Beta is the other aspect of volatility of a scheme in relation to the overall market. An effective way of understanding the performance of a scheme is to take into account both alpha and beta.




3. What should investors do if alpha is not generated?

One important aspect that Investors need to bear in mind is the category performance when alpha is generated. To explain, if a mid-cap scheme does not generate alpha, investors need to look at the average return of all schemes in mid-cap category. The scheme invested by you has fared well, if it has generated higher return than the average return. (Investors should consult their financial advisers before investing.)

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.