Alpha & Beta

Alpha and beta are also related to the regression line. As Figure 23 illustrates, alpha is the Y intercept of the regression line. In other words, if the benchmark returned 0%, the Y intercept would tell us what the investment could be expected to return. In Figure 23, the alpha is 2.23%. That means if the benchmark returned 0%, we would expect our investment to return 2.23%.

Beta is the slope of the line and measures the volatility of a particular investment relative to the market as a whole. (Note: The market can be defined as any index or investment.) Beta describes an investment’s sensitivity to broad market movements. For example, in equities, the stock market (the independent variable) has a beta of 1.0. An investment with a beta of 0.5 will tend to participate in broad market moves, but only half as much as the overall market.

Figure 23: Investment's Alpha and Beta - Take I

Investors who are required to select and monitor investment managers should develop a basic understanding of investment statistics. Quantitative tools can provide you with good insight that you can use in your qualitative interviews with managers and when monitoring your investments.