Alpha

A measure of the difference between a portfolio�s actual returns and its expected performance, given its level of risk as measured by beta. A positive Alpha figure indicates the portfolio has performed better than its beta would predict. In contrast, a negative Alpha indicates the portfolio has underperformed, given the expectations established by beta.

4Overview of Alpha

Is dependent on Beta.
Shows how the portfolio actually did compared to how it was expected to do, based on the portfolio�s beta. If a portfolio has a positive Alpha, it has done better than expected, given its risk level.
There isn't a scale for Alpha. Basically, a positive Alpha means the portfolio did better than expected, and a negative Alpha means it did worse than expected.
On a graph, Alpha is indicated by the point where the line crosses the y-axis.

4Use of Alpha

Alpha can be used to directly measure the value added or subtracted by a manager. Alpha depends on two factors: 1) the assumption that market risk, as measured by Beta, is the only risk measure necessary and 2) the strength of the linear relationship between the portfolio and the benchmark, as it has been measured by R-squared. In addition, a negative Alpha can sometimes result from the expenses that are present in a portfolio's returns, but not in the returns of the comparison index.

4Calculation

In computing Alpha, Morningstar deducts the risk-free return from the total return of both the portfolio and the benchmark index. Thus, the Alpha figures shown by Morningstar may be lower than those published elsewhere. Morningstar believes that the calculation of Alpha should represent the fact that every investor has choices about where to place his or her money.

Morningstar calculates a monthly measure of Alpha and then annualizes it to put it in a more useful one-year context.

Let,

be the return of a portfolio in month t