ABCs of Alternative Investing
Getting back to the basics.
Alpha measures the difference between a fund's returns above its benchmark risk exposure(s) (as measured by beta). A positive alpha figure indicates the fund has performed better than its beta would predict. In contrast, a negative alpha indicates underperformance. When selecting alternative products, investors should look at alpha to measure the value added or subtracted by a fund's manager. Alpha should be considered relative to both standard and alternative benchmarks (such as the Morningstar Long/Short Commodity Index, Morningstar Diversified Futures Index, or the Morningstar MSCI Hedge Fund Indexes.)
Beta measures a fund's sensitivity to market movements. By definition, the beta of a particular market (represented by an index) is 1.00. A beta of 1.10 means that, on average, the fund performed 10% better than its benchmark index in up markets and 10% worse in down markets, assuming all other factors remain constant. Conversely, a beta of 0.85 indicates that the fund gained 15% less than the market during an upturn and lost 15% less during down markets. Certain alternative strategies, such as long/short equity or multialternative, maintain higher equity beta exposure (between 0.30 and 0.80), while most market-neutral funds maintain betas to the S&P 500 Index of between negative 0.3 and 0.3.