What alpha means

Alpha is the return an investment earned beyond what you’d have expected given the risk it took. It’s the number every active fund manager is implicitly claiming to produce, and the number this blog’s mutual fund series has so far avoided using — because most of what gets called alpha is something else wearing the name.

There are two very different things people mean by it:

  1. Raw excess return — the investment’s return minus the benchmark’s. Simple, and usually what a factsheet or a headline means.
  2. Jensen’s alpha — the return minus what CAPM (the Capital Asset Pricing Model) says the investment should have earned, given its beta. This is the one that deserves the name.

The gap between the two is the whole lesson.

The formula

Raw excess return  =  R_investment − R_benchmark

Jensen's alpha     =  R_investment − [ R_f + β × (R_benchmark − R_f) ]

where  R_f  = risk-free rate
       β    = the investment's beta against that benchmark

The bracket is CAPM’s expected return: the risk-free rate, plus beta times the market’s excess return. A stock with a beta of 2 that returned 20% in a year the market returned 10% has no alpha — doubling the market is exactly what a beta of 2 is supposed to do.

Worked example: Britannia, two years

Daily closes from 1 April 2024 to 30 March 2026, the same series as the beta post (whose first daily return falls on the next trading day). Risk-free rate 6.5%, the illustrative G-Sec (Government of India bond) yield used throughout the WACC post. Historical data, for illustration only.

   
Britannia, annualised return 5.27%
Nifty 50 (price index), annualised −0.29%
Raw excess return 5.56 pp a year
Britannia’s beta over the window 0.42
CAPM expected return: 6.5 + 0.42 × (−0.29 − 6.5) 3.65%
Jensen’s alpha 1.62 pp a year

Same stock, same two years: the headline says Britannia beat the market by 5.56 points a year; the risk-adjusted version says 1.62. The difference is that the Nifty had a poor two years — the price index actually fell slightly — and a stock with a beta of 0.42 was expected to fall less. Most of the “outperformance” is just low beta doing what low beta does in a weak market. Reverse the market and the same low beta would have made Britannia look like a laggard.

One honest caveat on the inputs. Both returns here are price-only: Britannia’s share price and the Nifty 50 price index, with dividends left out, because a total return index series isn’t in this post’s data. That’s the very mistake the next section warns about. In the raw comparison the two missing dividend streams partly cancel. In the CAPM line they don’t: the risk-free rate is a full yield, but the market return it’s compared with is missing its dividends, so the market’s excess return is understated. Treat the alpha figure as rough — it illustrates the method, not a precise measurement.

Neither figure says anything about Britannia’s prospects. It’s two years of price history, and the beta post already showed that the beta itself moved from 0.29 to 0.55 across those two years — so the alpha number inherits every bit of that instability.

The fake alpha in every index fund factsheet

Here is a more instructive example. Take the UTI Nifty 50 Index Fund (regular plan) — a passive fund whose entire job is to match the index — and compute its calendar-year return minus the Nifty 50 price index:

Year Fund Nifty 50 (price) Difference
2016 4.0% 3.01% +0.99 pp
2017 29.68% 28.65% +1.03 pp
2018 4.26% 3.15% +1.11 pp
2019 13.25% 12.02% +1.22 pp
2020 15.5% 14.9% +0.6 pp
2021 25.2% 24.12% +1.08 pp
2022 5.33% 4.33% +1.0 pp
2023 20.89% 20.03% +0.86 pp
2024 9.64% 8.8% +0.84 pp
2025 11.57% 10.51% +1.06 pp

Ten years, ten positive numbers, averaging +0.98 pp a year. Sources: fund NAV from AMFI via mfapi.in; index from Yahoo Finance. Data to 31 March 2026.

An index fund with a decade of positive “alpha” is obviously nonsense — and it is, because the benchmark is wrong. The price index (PRI) ignores the dividends the fifty companies pay; the fund receives and reinvests them. That one-point gap is roughly the Nifty’s dividend yield minus the fund’s expense ratio. Against the total return index (TRI), which includes dividends, the same fund would likely show a small negative number most years — the expense ratio and tracking error, which is what an index fund is supposed to show.

This is exactly why the benchmarks post insisted on comparing like with like, and why SEBI has required funds to benchmark against TRI since February 2018. Before that, a lot of Indian active-fund “alpha” was this dividend gap.

🧒 Explain it like I'm 10 (optional — skip if this is already clear)

Your friend says she’s a better runner than you because she finished the race 30 seconds ahead. But she started 30 seconds before you did. Once you account for the head start, she didn’t beat you at all.

Alpha is the finishing time after subtracting head starts. Beta is one head start (some runners just get a tailwind when the whole field does). Dividends the benchmark forgot to count are another.

Common mistakes

  • Calling excess return “alpha”. Excess return over a benchmark is a fact. Alpha is that fact with the risk taken to earn it subtracted out. A high-beta fund in a bull market has lots of the first and often none of the second.
  • Benchmarking against a price index. It manufactures about a point a year of alpha out of dividends. Always check whether a comparison uses PRI or TRI.
  • Reading alpha over a short window. Two years of Britannia produced an alpha estimate built on a beta that nearly doubled inside the window. Alpha needs a horizon long enough for the beta to mean something, and even then the standard error is usually larger than the estimate.
  • Assuming past alpha persists. The consistency of the index fund’s “alpha” above is the exception — it’s a structural artefact. Genuine manager alpha is hard to find at all: S&P’s SPIVA India Year-End 2025 scorecard found about 76% of Indian active large-cap funds trailed their benchmark over the ten years to December 2025. Finding it and expecting it to continue is harder still.

Takeaway: alpha is what’s left of a return after the benchmark and the beta are accounted for. Britannia’s 5.56-point lead over a weak Nifty shrinks to 1.62 once its low beta is credited — and an index fund’s decade of “outperformance” over the price index is dividends, not skill.