Which statement best defines alpha in portfolio management?

• A. Alpha is the total return of the portfolio before adjusting for risk.
• B. Alpha measures risk exposure relative to the benchmark.
• C. Alpha is the return in excess of a benchmark after adjusting for risk; indicates manager skill or strategy value-add.
• D. Alpha is the standard deviation of portfolio returns.

Answer: (C)

Alpha reflects the portion of portfolio performance that comes from manager skill or strategy after accounting for risk. In practice, returns come from market exposure (beta) and from stock-picking or timing (alpha). The benchmark captures the market part, so alpha is what’s left over once you adjust for that risk. It’s often viewed as the intercept in the regression of portfolio returns on market returns, or computed as actual return minus the risk-free rate plus beta times the market excess return: alpha = actual return − [risk-free rate + beta × (market return − risk-free rate)]. A positive alpha means the manager added value beyond the risk taken; a negative alpha means underperformance after risk is accounted for. For illustration, if a portfolio returns 8%, the risk-free rate is 2%, the market returns 6%, and beta is 1, then the expected CAPM return is 2% + 1×(6%−2%) = 6%, so alpha is 2% (positive), indicating added value.