Alpha
What does it mean when an asset beats a benchmark, and how do you measure the part of the return the benchmark did not deliver?
In plain words
Alpha is the part of an investment's return that exceeds what a chosen benchmark would have delivered over the same period. It is usually shown as a percentage or percentage points. Beating a benchmark can come from picking the asset, from leverage, or from simple luck in a short window.
Why it matters
Bare returns say little on their own. If a market rises, some of that gain was available to anyone holding the broad market. Alpha separates the manager's or asset's own contribution from the tide that lifted everything, which is what a risk taker is actually paid for taking.
In a real week: BTC, week of 28 June 2021
In the week of 28 June 2021, BTC rose 1.68%, from an open of 34702.49 to a close of 35286.51. Using BTC as the benchmark, ETH's weekly return exceeded BTC's by 15.49 percentage points. Both assets moved in the same direction and were closely correlated at 0.88, so part of ETH's excess tracked a shared market move rather than standing alone as alpha over this single week.
A common mistake
Treating a short window's outperformance as skill. One week of excess return can be noise, especially when the two assets are highly correlated, as they were here.