An investment fund’s returns can often be broken down into two sources: beta and alpha. Beta is the portion of return that can be attributed to the performance of the overall market, while alpha generally comes from a manager’s skill.

Alpha is often mistaken for “Excess Return,” which is simply the difference between the return of a fund and a benchmark, but Alpha is actually the additional return generated given the amount of risk assumed. Alpha can play an important role in portfolios, and it is important for investors to ensure that they are getting the Alpha they’re paying a premium for rather than just expensive beta.

The category “alternative investments” comprises both alternative assets and alternative strategies. The returns of portfolios that invest in alternative assets, such as commodities, real estate investment trusts (REITs) or master limited partnerships (MLPs), are typically driven by the beta of the asset class itself.

Alternative strategies, such as equity long/short or multi-strategies, aim to generate much of their returns from Alpha.

Historically, funds that have done well in delivering Alpha have also done well at mitigating drawdowns and delivering high risk-adjusted returns. In addition, alternative strategies that have low volatility can also help investors avoid trying to time the markets. Historically, bad timing decisions have caused investors to realize personal returns on their investments that are far below what the asset classes they had selected actually delivered. Strategies that help investors remain invested can keep them on track to pursue their long-term financial goals.

For additional insights into the different drivers of returns, read our paper: Alternative Strategies Are Often a Good Source of Alpha and Risk Management.

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