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Nov28
Alpha & Beta
I was asked to explain a little more about beta and alpha.  Betas are large asset categories like value stocks, growth stocks, small cap stocks, large cap stocks, treasury bonds, corporate bonds, municipal bonds, precious metals, commodities, real estate, etc.  These markets have a tendency to have better returns over time than an investment in cash would have. 

Alpha is the return a manager gives you above or below the average the markets you are invested in give you.  I will use an example to illustrate.

Say the S&P500 goes up 10% in 2005.  That is a beta of 10%.  Now suppose that your broker at Merrill Lynch has you buy more of some stocks in the S&P500 index and less of others.  As a result of his efforts you have an additional return in your portfolio of 1.5% after transaction costs.  So your total return for the portfolio is 11.5% for 2005.  You have a beta return of 10% and an alpha return of 1.5%.

The next year, the S&P500 goes up 10% again.  Your broker has you over and under weight other stocks.  As a result, you have a lower return of 1.0%.  Your total return for the year is 9%.  You have a beta return of 10% and a negative alpha of 1%.

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