“Alpha”: a vexatious lexigraphic obfuscation*

CAPM / Alpha Theory 17 May 2007

It is common that certain cultures have numerous words for ubiquitous things in their society.  For example, the Inuit (Eskimo) have over 30 words for “snow”, the Chinese have a dozen words for “rice”, and the British have many words for “stream”.  But in the world of investing, there seems to only be one word for what is ostensibly its raison d’etre: alpha.

Maybe I’m working too much.  But the more I research alpha, the less I know how to define it.  While Andrew Lo asks “Where does alpha come from?”, I’m now back at “What is alpha”?  For example, what might look like alpha over one timeframe is actually “exotic beta” when you shift the window of analysis only a few months.  What looks like alpha vs. one benchmark may, of course, be beta when compared to a different benchmark.  There’s “active weight“, “active component“, “active share“, “absolute returns”, “reliance on public information“, “manager value-added” – even “accidental alpha“.

Compounding the confusion are a seemingly infinite variety of definitions of alpha on the Internet.  When I get an email asking me to define the beautiful variable, I have resorted to replying with a list of over a dozen definitions pulled from various sources.  That list contains some pretty accurate definitions:

“Alpha measures nonsystematic return, or the return that cannot be attributed to the market; how the manager performed if the market had no gain or loss.”

…and some downright otiose* ones:

“Alpha is a measure of residual risk (sometimes called “selecting risk”) of an investment relative to some market index. For all the gory details on Alpha, please see a book on technical analysis.”

The latest person to attempt to define the “unexplainable” is Unicredit‘s Timothy Laing.  Tim works the structured products area at the “Truly European Bank” and has put together a more in-depth discussion of several definitions of alpha for his own internal use.  He has allowed us to host the document here.

Laing examines the definitions put forth by several thinkers in the area – from practitioners to academics and from the main stream media to bloggers.  He reviews some of the more esoteric and creative definitions of alpha and the more straightforward practical ones. What’s clear in his brief survey of the lexigraphy is that we desperately need more words to describe out-performance.  (How about the Aramaic ‘aleph’ or maybe something colourful from the Aztec alphabet.)

The fact is, if you said “alpha” in front of a group of 50 people, there would surely be 50 different interpretations.  Pardon the pleonasm*, but what an ineluctably* flagitious* eventuation*!

* with special thanks to Roget’s New Millennium Thesaurus (even though it offers nothing propitious for “alpha”).

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One Comment

  1. Max Reydman
    May 25, 2007 at 7:52 am

    Thank you for acknowledging the confusion surrounding of definition of Alpha.

    As a portfolio manager, I frequently think about what makes my clients happy †Alpha, Beta or other feted or feared letters of the Parthenon. Perhaps it would be useful to focus on the various investment return properties that make Investors happy in order to understand what ‘Alpha’ is from their perspective?

    In my experience, the following the three factors consistently rank highest as Investor pleasers: 1) expectation of positive performance above their benchmark; 2) stability of the return distribution, especially in the tails; and 3) the diversifying properties or lack of correlation of the Manager’s returns versus other portfolio holdings.

    Institutional investors seek out these qualities. Maybe investment managers ought to focus on delivering these tangibles, rather than questing for ‘ubiquitous Alpha’?


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