19 – L1 18 Alpha And Beta V3

Note that Active Funds, are sometimes called Alpha Funds. While Passive Funds are sometimes called Beta Funds. So, where do the names alpha and beta come from? Well, alpha and beta refer to the intercept and coefficient of a regression line. In particular, this is the regression of a portfolio’s return against the markets return in excess of the risk-free rate. In general, a portfolio’s excess return, is the portfolio’s return minus the risk-free rate. A beta coefficient of one means that a two percent increase in the market, will also result in a two percent increase in the portfolio. An intercept or alpha of one means that the portfolio has a one percent return that exists, even if the market’s excess return is zero. You’ll get more details about this particular regression line in a later lesson about portfolio optimization. But the goal of an active fund, is to generate excess returns above the market’s excess return. Hence, is called an Alpha Fund. The goal of a passive fund is to closely match the returns of the market that is tracking. So, it’s called a Beta Fund.