JENSEN’S ALPHA

Summary

Jensen's Alpha is a risk-adjusted performance measure that tells you whether a portfolio manager is adding value beyond what you'd expect from the market risk they're taking. It compares the actual returns of a portfolio to what the Capital Asset Pricing Model (CAPM) predicts those returns should be, given the portfolio's beta (market risk). A positive alpha means the portfolio outperformed expectations, while a negative alpha indicates underperformance. Think of it as a report card for investment skill - it separates lucky market timing from genuine stock-picking ability.

Usage Context

Jensen's Alpha is crucial when studying portfolio performance evaluation, comparing mutual fund managers, understanding risk-adjusted returns, and learning about the CAPM model's practical applications in investment analysis.

Common Confusions

• Confusing alpha with total portfolio returns - alpha is excess return after adjusting for risk
• Thinking high returns always mean good performance - a high-beta portfolio should have high returns
• Believing alpha measures all types of risk - it only adjusts for systematic (market) risk
• Assuming alpha is constant over time - it can vary with market conditions and manager skill