Alpha

of the market.

So if there's just greater risk being taken, that's not alpha.

Alpha is an excess return that is not explained by excess risk, at least excess stock market risk.

and so hedge funds are supposed to give you this sort of positive return in excess of the market and they're supposed to be uncorrelated to the market so they're supposed to be able to give you maybe an update when the market is down an up year when the market is down but equally in an up year or an up day for the market you shouldn't necessarily expect a hedge fund to be up because essentially the investments and as you see when we go through the different strategies there's not really a good reason to expect a hedge fund strategy to be correlated to the stock market because usually what the hedge fund manager tells you they are doing is quite different to the the risk that's been taken with a simple stock market investment so The very first hedge fund and actually how hedge funds got their name was through this guy here, Alfred Winslow Jones, who launched his fund in 1949.

And he did a certain amount of analysis around momentum and mean reversion in stocks, worked out how far stocks deviated from fundamental value using kind of corporate finance valuation techniques.

But I'm not going to fire you because your Jensen's alpha is negative, because if your Jensen's alpha is only minus 11%, you say, what do you mean only minus 11%? And the average oil company has a Jensen's alpha of minus 25%.

You're a hero.

So when you look at Jensen's Alphas, before you make that jump and say, this must mean my company has good management, just step back and ask, where did that Jensen's Alpha come from? How much of it was coming from outside forces, the sector itself, and how much is coming from the management? So let me ask you a final question.

Disney looks like a pretty good company in 2013.

If Jensen's Alpha is positive, it's done much better than the market.

We have to start separating our companies from management to investments because there are three different levels at which you're gauging the company.

And at this stage, all you're looking at is the past of the company and saying, hey, this company was a good investment or a bad investment.

Any questions on Jensen's Alphas? Yes? It's that's the biggest, because two things happen.

why don't we break down what alpha, beta, cost and of course risk is for our listeners.

So let's start with alpha.

So what is alpha? Alpha is the term we describe as extra returns.

So what does it mean? It's basically above and beyond what the market delivers to you.

So we say when we are investing, we're investing into the stock market, the bond market, the real estate market, and so on and so forth.

And alpha is really trying to beat what Beta is giving investors.

But of course, with that, we have to consider things like risk and cost, which we will talk more about later.

So if you compare the Beta and Alpha, we got into a little bit.

Mm-hmm.

But the first big statistical characteristic is, is what Katie Kaminski coined Crisis Alpha.

Um, and, and so if you look at the, the three major crises, and so when we define crisis, we mean an equity bear market.

Mm-hmm.

Um, the third characteristic is, um, is, is alpha generation.

And, and people with propellers spinning on their head get into arguments with me about this.

I wrote a paper called like Lies, Damn Lies, and Alpha.

Alpha can be used and misused.

Alpha, beta, and the Sharpe ratio are central risk-adjusted performance measures on the Series 66 exam.

To master these concepts for test day, investment advisor representatives must understand how each metric accounts for different types of risk and return.

Beta measures systematic risk, which is non-diversifiable market risk.

A benchmark index like the Standard & Poor's 500 has a beta of exactly 1.0. An equity portfolio with a beta of 1.2 is expected to be 20% more volatile than the broad market, moving up or down by 1.2 times any market move.

Conversely, a portfolio with a beta of 0.8 is 20% less volatile than the benchmark.

Alpha measures risk-adjusted excess return, representing performance above or below what systematic risk would predict.

On the Series 66 exam, expected return is calculated using the capital asset pricing model formula.

In this model, expected return equals the risk-free rate plus beta multiplied by the market risk premium, which is the market return minus the risk-free rate.