What is Alpha? - MoneyWeek Investment Tutorials

Like this MoneyWeek Video? Want to find out more on Alpha? Go to: http://www.moneyweekvideos.com/what-is-alpha-2/ now and you'll get free bonus material on this topic, plus a whole host of other videos. Search our whole archive of useful MoneyWeek Videos, including: · The six numbers every investor should know... http://www.moneyweekvideos.com/six-numbers-every-investor-should-know/ · What is GDP? http://www.moneyweekvideos.com/what-is-gdp/ · Why does Starbucks pay so little tax? http://www.moneyweekvideos.com/why-does-starbucks-pay-so-little-tax/ · How capital gains tax works... http://www.moneyweekvideos.com/how-capital-gains-tax-works/ · What is money laundering? http://www.moneyweekvideos.com/what-is-money-laundering/

Comments

1. Could you make a tutorial on how to make a financial model?
   Thanks.
2. This is a good video with a good teacher with what can easily be ascertained to have good ethics and good morals. Just a great overall person in my opinion from an intuitive feel. So what I am about to mention has nothing to do with anything negative toward the teacher's way. And he probably knows what I am about to say, but his presentment is to keep it simple...because that is what his videos mostly do...take some more complicated information and presents it in a very simple way to learn the basics.
   
   However and to more deeply mention, what is being described is actually what is called active return and not alpha. Alpha gets a little more complex but not really much more. Alpha is actually the average portfolio excess return - (beta x average market excess return).
   
   So, if we have the following:
   
   Average Portfolio Excess Return: 11%
   Average Market Return: 7%
   Active Return: = 11% - 7% = 4%
   Beta: 1.30
   Alpha: = 11% - (1.3 x 7%) = 1.90%
   
   You can see there is quite a substantial difference of 2.1% between active return vs. alpha for this example. There is also the fact of the error term in the least-squares regression that is the noise factor, i.e. luck. So this needs to be separated from what is skill to really understand if there is any alpha generation, thus warranting the associated fund manager fees rather than choosing to invest more passively and cheaply in say index funds, mutual funds, ETFs, etc. so that one's portfolio value is not being eroded over time.
   
   Additionally and to provide some deeper insights in conjunction with the video, the CAPM-SML (Capital Asset Pricing Model - Security Market Line) = risk-free rate + beta ( risk premium)...which is used to generate an expected return that the fund manager supposed to be able to beat through skill.
   
   where, beta = std. dev. of stock  x std. dev. of market / correlation coefficient between stock and market = covariance between stock and market / std. dev. of market^2
   
   As mentioned, this can be highly subjective and easily manipulated downward to make it look like one is achieving alpha. For example, one will get different values to plug into risk-free rate and beta depending on the time-frame of the data gathered such as 1 year, 3 years, 5 years, 10 years, etc. Someone who is not knowledgeable of this can be easily duped. Additionally, the risk premium is a guestimate usually between a particular range of say 3% to 6% or so (it is in fund manager's interest to choose 3% or say 4%...the lower numbers to shower lower expected return as calculated by CAPM-SML). Furthermore, beta's calculation depends on having an accurate market-proxy for all risky assets for the entire universe. Of course this is not possible to obtain, and therefore, beta calculation is not accurate. The bottom line is that there are a lot of assumptions as mentioned in the video and through using the Fama-MacBeth regression method, one can show that the CAPM does not hold up very well...however, Roll's critique can show that there is no way to test the validity of the CAPM due to there being no way to obtain data for the risky assets of the entire universe which includes stocks, bonds, stamps, art, etc.
   
   Consequently, and due to the above, one can easily see how a fund manager can manipulate the numbers in their best interest!
   
   It is important to be knowledgeable for protecting one's own best interest because most people in this day and age only care about numero uno. So best thing is to educate and have a decent dose of cynicism before buying someone's pitch. Observe their face...their style...etc. A lot can be ascertained from that alone and although not always correct can provide vital clues for making more informed business decisions.
   
   Good luck!
3. Really glad to see you guys have over 100 thousand subscribers now, i've seen a fair amount of your video's by now and it's always great information put in an easy format to understand, love it thoroughly.
4. You are talking about excess return right? Not alpha.
5. how calculated capitalized predicted return and actual return on stock
6. totally agree with the author on refusing the alpha idea. Not only used accross the fund industry but as well in many consultancy companies (they love this stuff in deloitte) when it comes to value companies. They have an obsession in using alpha for their wacc calculations, therefore affecting the free cash flow result, so they can deliver very conservative reports to cover their own arses in all times.
7. A good one.
8. Might be better to diversify and invest in shares that pay divident as an insurence against the alpha?
9. Before you quickly dismiss Alpha, you should take a look at some of the world's most successful hedge fund managers who persistently blew the benchmarks out of the water year after year.  Many of those are American although Britain and some other countries have produced incredible fund managers as well.  Here's an example: George Soros' Quantum Fund returned 600% (SIX HUNDRED PERCENT) per year for 10 years (that's a total of 6,000% return) for his investors.  So...he just got lucky during that decade?  Edward Thorpe has been able to produce for over 20 years an average return of 50% compounded annually.  Again, luck?  I think a more modest claim to make in this video should be that if you're not an accredited investor ($250k/year income or $1M liquid), you pretty much can't afford alpha.  Here in the US, our government doesn't allow you to really invest in those kinds of funds unless you are accredited.  
10. Agreed. When going over these models I felt more like an economist than a finance major. These videos give a real perspective and I love it.
11. yes mam. penny stocks have been booming in past 2 years and thats the great way to make money from trading fast. be mature and do this, One of my friend making tons of money from penny stocks with professional easy guidance. have a try and make the most of them :) >>> bit.ly/18JLcb9?=menfss
12. As always great and honest mini lectures which can easily be applied. We spent a ton of hours going through the CAPM in business school, and it is a good model to use for some purposes, but it has a great deal of assumptions that just isn't realistic. Also, you should make annotation links when ever talking about other videos. The links can be opened in a new tab. That would be quite useful.
13. Good video, as always. In a fund we are creating the promise of alpha was linked with the fund's duration. As the fund has a limited time in this case, the fix commission will be vested annually, but the performance fee will be vested at the end of the life of the fund and will be based on the final IRR. It's not something applicable to all types of funds and unfortunately is a model reserved to institutional market and qualifying investors.
14. Well now that i know about Alpha i understand why fund managers want people to know about Alpha lol. Started trading imaginary money recently and today made myself £3500 buying then selling silver. Was very lucky. Got it at the bottom before it started to shoot up today, and sold my imagnary silver a few minutes ago. I should be charging alpha too :P.
15. Just started to get into the whole stocks/investment topic recently and your videos are very helpful. Thanks.