Jensen’s Alpha

Given the portfolio’s or investment’s beta and the average market return, Jensen’s Alpha is a risk-adjusted performance metric representing the average return on a portfolio or investment above or below the capital asset pricing model (CAPM) predicted. Simply put, Alpha is the name given to this statistic.

Example of it:

Jensen’s Alpha=Rp-[Rf+Bp*(Rm-Rf)

Where,

Rp = Expected Portfolio Return

Rf = Risk-Free Rate

Bp = Beta of the Portfolio

Rm = Expected Market Return

A portfolio has realised a return of 15%. The approximate market index returned 12%. The fund’s beta versus the same index is 1.2, and the risk-free rate is 6%.
Jensen’s Alpha = 15 – [ 6 + 1.2 * (12 – 6) ] = 1.8%

Why is it vital to know Jensen’s Alpha?

As a fundamental practice of analysing our investments, investment managers are responsible for showing their performance against a given benchmark. Jensen’s Alpha is one of the known measures utilised to measure the fund’s performance.

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