There are a large number of variables to understand the effectiveness of one's market investments. Simplistically speaking, tracking a scheme's returns is a variable that gives a fair sense of whether one's investments were profitable or not. But does the return of a scheme provide some nuances capable of capturing the benefits or disadvantages of being invested with a scheme? Can one consider a variable capturing certain nuances associated with the returns of understanding to a considerable degree? Alpha is one such variable.
What's that alpha?
Alpha is a key barometer in mutual funds. Comprehension of alpha helps to understand the soundness of one's investment in a scheme. A scheme typically has an index that is benchmarked for its composition. A large-cap scheme, for example, could have a BSE 100 benchmark index. Take two cases now. One is that the scheme yields 25 percent and its BSE 100 benchmark yields 10 percent in a year. In the second case, the same scheme yields 10% and its BSE 100 benchmark yields 20%. The scheme delivered 15% higher returns in the first case than the benchmark.This excess return is the alpha that the scheme could produce. The scheme has even failed to keep pace with the returns of the benchmark in the second case, which points to a variety of possibilities. It may be possible that the markets are in a bearish phase, and it has become difficult to spot investable and profitable ideas. The fund manager may also have failed to capture interesting ideas that would have boosted the returns. Alpha means the excess returns generated by a scheme beyond and beyond the returns generated by its benchmark index.
Alpha is a key barometer in mutual funds. Comprehension of alpha helps to understand the soundness of one's investment in a scheme. A scheme typically has an index that is benchmarked for its composition. A large-cap scheme, for example, could have a BSE 100 benchmark index. Take two cases now. One is that the scheme yields 25 percent and its BSE 100 benchmark yields 10 percent in a year. In the second case, the same scheme yields 10% and its BSE 100 benchmark yields 20%. The scheme delivered 15% higher returns in the first case than the benchmark.This excess return is the alpha that the scheme could produce. The scheme has even failed to keep pace with the returns of the benchmark in the second case, which points to a variety of possibilities. It may be possible that the markets are in a bearish phase, and it has become difficult to spot investable and profitable ideas. The fund manager may also have failed to capture interesting ideas that would have boosted the returns. Alpha means the excess returns generated by a scheme beyond and beyond the returns generated by its benchmark index.
Understanding the nuances of alpha and beta
The concept of volatility is a key factor for investors to consider in understanding returns. In terms of a scheme, this could be understood. The scheme is linked to one aspect of volatility. It means how volatile the portfolio of the scheme is in relation to its average. And the other aspect of volatility, which is its benchmark index, is associated with the markets. This volatility aspect is called Beta. Taking into account both alpha and beta is one of the effective ways of understanding how a scheme prices holistically. It becomes an attractive investment option if a scheme scores well on both of these variables.
The concept of volatility is a key factor for investors to consider in understanding returns. In terms of a scheme, this could be understood. The scheme is linked to one aspect of volatility. It means how volatile the portfolio of the scheme is in relation to its average. And the other aspect of volatility, which is its benchmark index, is associated with the markets. This volatility aspect is called Beta. Taking into account both alpha and beta is one of the effective ways of understanding how a scheme prices holistically. It becomes an attractive investment option if a scheme scores well on both of these variables.
If there is no generation of alpha, then what?
The key challenge was to generate alpha. A line of thinking that is gaining currency among high networth individuals over the past two years is passive fund attractiveness compared to active funds. This is because the alpha could not be generated by a large number of equity schemes. This is one of the main reasons why HNIs prefer to invest in exchange traded funds (ETFs) rather than actively managed funds. Such a tactical shift occurs in a cyclical market phase. But when generating alpha, the category performance of the scheme is an important aspect that investors need to bear in mind.For example, if a large-cap scheme does not generate alpha then looking at the average return of all large-cap schemes is important. If your investment scheme generates higher returns than the average return, it has served well as a profitable investment.
The key challenge was to generate alpha. A line of thinking that is gaining currency among high networth individuals over the past two years is passive fund attractiveness compared to active funds. This is because the alpha could not be generated by a large number of equity schemes. This is one of the main reasons why HNIs prefer to invest in exchange traded funds (ETFs) rather than actively managed funds. Such a tactical shift occurs in a cyclical market phase. But when generating alpha, the category performance of the scheme is an important aspect that investors need to bear in mind.For example, if a large-cap scheme does not generate alpha then looking at the average return of all large-cap schemes is important. If your investment scheme generates higher returns than the average return, it has served well as a profitable investment.
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