What Is Alpha: Meaning In Mutual Funds, Calculation & Investor Relevance

• Alpha in mutual funds measures how much better (or worse) a fund performs compared to its benchmark.
   
• A positive Alpha means the fund beat the market; a negative Alpha shows underperformance.
   
• Investors should not rely on Alpha alone, it must be checked with Beta, Sharpe ratio, and other metrics.
   
• Alpha is a backwards-looking measure, useful for judging fund manager skill, not for predicting future returns.
   

Alpha in mutual funds is a performance metric that shows how well a mutual fund has performed compared to its benchmark index.

Ravi Mehta, a 35-year-old school teacher in Jaipur, started investing in mutual funds in 2023. He put ₹5,00,000 into a fund that promised good returns. After one year, his fund grew to ₹5,75,000, giving him a return of 15%. During the same time, the market index (like Nifty 50) grew only by 10%.

Ravi was happy but confused. Why did his fund do better than the market? That’s when he read about something called Alpha. He learned that Alpha tells us how much more (or less) return a mutual fund gives compared to the market. In Ravi’s case, the Alpha was +5%.

In this blog, you'll learn everything about Alpha in mutual funds, what it means, how it's calculated, why it's useful, and how it compares to other tools like Beta, Sharpe Ratio, and R-Square.

What is Alpha in Mutual Funds?

Alpha is a number that tells you how much extra return a mutual fund gave you compared to what was expected. In easy words, if Alpha is positive, it means your fund did better than the market. If it's negative, it did worse. Alpha helps you know if the fund manager made smart choices or not.

Recently, on 6th August, Kotak Mutual Fund has introduced the Kotak Nifty Alpha 50 Index Fund, an open-ended scheme tracking high-alpha stocks for long-term growth.

Let’s take an example: Ramesh, a 38-year-old school teacher, invested ₹10,00,000 in a mutual fund in 2024. By 2025, the market had grown by 8%, so he expected to earn ₹80,000. But his fund gave him a return of ₹1,10,000. That means he earned ₹30,000 more than expected. This extra return is known as Alpha.

How to Calculate Alpha in Mutual Funds?

Alpha is found using a formula from something called CAPM (Capital Asset Pricing Model). Don’t worry, it sounds big but is easy to understand when broken into parts.

Here’s the formula:
Alpha = Actual Return – [Risk-Free Rate + Beta × (Market Return – Risk-Free Rate)]

Let’s explain each part.

Read More – Active vs Passive Investing: What’s the Difference and Which is Better?

Let’s use an example: Asha, a small business owner, invested ₹5 lakh. The market return was 10% and the risk-free rate was 5%. Her fund gave her 12%, which means she earned ₹60,000. The expected return was only 10%, or ₹50,000. So, she got ₹10,000 extra, which means Alpha = 2%.

This table breaks down the key parts of the Alpha Formula in a simple way, using Asha’s fund as an example: 

Alpha shows how much extra return a fund earns after accounting for market risk, helping investors judge real performance.

Relevance of Alpha to Investors

Alpha tells you how well the fund manager is doing. If Alpha is high, it means the manager picked the right stocks. For both regular people and big companies, Alpha shows if the fund is worth the risk.

As someone once said in a film, “Risk toh Spiderman ko bhi lena padta hai, main toh sirf mutual fund mein invest kar raha hoon!”

This means: if superheroes take risks, smart investors can too, but only after checking the fund’s Alpha.

What Different Alpha Values Mean?

A higher Alpha means the fund is adding real value, while a negative Alpha signals underperformance.

Now, meet Mohan, a new investor. He wants to choose between two funds:

• Fund A has an Alpha of +1.5
• Fund B has an Alpha of –0.5

Mohan invested ₹2,00,000 in each. Fund A gave him ₹30,000, while Fund B gave only ₹15,000. He understood that Fund A's high Alpha meant the fund manager did a better job.

Alpha vs Beta in Mutual Funds

Alpha shows how much extra return a mutual fund gives compared to the market. If a fund has an alpha of +2, it means it gave 2% more return than the market.

Beta shows how much the fund moves when the market moves. If beta is 1.2, and the market goes up by 10%, the fund may go up by 12%. But it can also fall more if the market goes down.

Both Alpha and Beta help in understanding how a fund behaves. Alpha shows how smartly the fund is managed. Beta shows how risky the fund is.

Also Read - This Mutual Fund Has Given Over 20% Return in Its First Year, Beating the Benchmark

Example: Sunita is 28 and wants to grow her money fast. She picks a fund with high beta (1.5) because it can grow fast when the market goes up.

Raj, who is 45, wants steady returns. He chooses a high alpha fund (+3%) that beats the market but stays stable.

Alpha vs Beta – Key Differences

When evaluating mutual funds, two key metrics often come up: Alpha and Beta. While both help assess performance, they reveal very different things about how a fund behaves:

Both Alpha and Beta gives a clearer picture of not just how well a fund performs, but also how much risk you're taking to get those returns.

How Alpha Helps in Fund Selection?

Alpha is very helpful when picking a fund. It shows how well the fund manager is doing. If two funds have the same return, the one with higher alpha is managed better.

But alpha should not be the only thing to check. It is important to look at risk, fund size, past record, and other ratios too.

Example: Ravi, a 30-year-old IT worker, wanted to invest in a tax-saver ELSS fund. He checked 3 funds and saw that one had a 3-year alpha of +2.8. That meant it gave 2.8% more than the market. He picked that fund after also checking its returns and ratings.

But wait, Alpha alone is not enough. Let’s look at other important mutual fund ratios you should know before investing.

Common Misconceptions About Alpha

Many people think alpha always means good performance. That’s not true. A high alpha can also come with high risk. Some even believe alpha means guaranteed returns. But no return is ever guaranteed.

Example: Suresh, a 34-year-old investor, thought a mutual fund with 8% alpha would give him 8% returns over market gains. He didn’t check the fund’s risk level or period. Later, the fund lost money. Suresh learned that alpha is just one number. It tells how the fund did in the past, but not what it will do in the future.

When Not to Trust Alpha Alone?

Alpha can be tricky if you only look at it for a short time. A fund may show a good alpha in one year but perform badly later. That’s why it's better to check alpha across different time periods and use tools like rolling returns.

Also, alpha should be seen along with other data like beta, Sharpe ratio, and standard deviation. If you only follow alpha, you might choose the wrong fund.

SEBI, India’s market regulator, has also warned investors not to chase performance based on past alpha alone. Always do your homework.

Conclusion

Alpha is a helpful tool, but not the only one. It shows how well a fund manager has done compared to the market. But before trusting it, look deeper. Always read the fund fact sheet. Ask your financial advisor. Use fintech apps to compare returns, risk, and ratios. Choose funds based on full research, not just one number.

FAQs on What Is Alpha in Mutual Funds?

Q1. Can Alpha in mutual funds change every month?
Yes, Alpha is dynamic. It moves with market changes, fund manager decisions, and sector performance, so it should be tracked regularly.

Q2. Is Alpha in mutual funds better for active or passive funds?
Alpha is mainly relevant for actively managed funds. Passive index funds usually have Alpha close to zero.

Q3. What Is Alpha in mutual funds when choosing ELSS (tax-saving) schemes?
Investors often use Alpha to compare ELSS funds. A higher Alpha in ELSS suggests better fund manager skill in beating benchmarks.

Q4. Does Alpha in mutual funds matter if I only invest through SIPs?
Yes. Even in SIPs, funds with a consistently high Alpha can give you extra returns compared to market averages.

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