I was trying out the models developed by hedge funds, their strategies and portfolio management style. Applying their model onto my fund was already a challenging task, since I am a one-man resource.

Then I started thinking of measuring my performance. As a common phrase, you can’t manage and improve what you cannot measure. So I started to look at measurement metrics, and after going through tons of hedge fund books, I’ve found the term “Alpha” which also signify how well a fund perform in returns. It is also how the website Seekingalpha.com got its name after. ( And thanks to the book “The Quants” for giving me such knowledge.)

Now the main aim of the fund is to seek positive Alpha, and with a good Alpha, a fund manager can demand higher management fees ie. 1.5%, 2%per year of the total invested Capital. Well, getting better at Alpha remains a Mystery (kudos to Citadel who has the answers)

Now just how do we calculate Alpha ?

We need a few inputs, this gets a little mathematical~

- Returns / Gain in %
- Interest rates in %
- S&P500 returns in % (YTD, Monthly, quarterly etc) and depending on what index you want to – bench mark with
- Overall portfolio beta in value

To calculate returns %
Take your realized profits minus starting capital to percentage points. (since the date you want to measure)

To get interest rates %
Simply look at the Fed rates.

To get Index Returns %
Take the up to date value over the starting index, to percentage points. (since the date you want to measure)

To get Overall Beta in value
Browse at finance.google.com and get its beta for each and individual stock, add all of them up and average them out.

And heres the formula:
Alpha = Return% – Interest rates% – (S&P500% * 2)

Eg:
- Returns = 24%
- Interest rates = 2.0%
- S&P500 returns 12%
- Beta = 0.78%

Alpha = 24% – 2% – (12*0.78)
= 22% – 9.36%
= 12.64 %

Walla, your total Alpha to this date for your fund is 12.4%, and you can mostly charge your clients a good management fees if you can generate this returns over any market conditions.

Another example:
- Returns = 4%
- Interest rates = 1.0%
- S&P500 returns -9%
- Beta = 1.4%

Alpha = 4% – 1% – (-9*1.4)
= 3% – (-12.6%)
= 15.6 %

Wow not bad if your fund is able to get a 4% returns when the markets dropped a huge 9%.

Hope your calculate your own portfolio’s Alpha and compare it with the professionals!

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Managemoneyonline.com is a website, a blog that I have created to write down my ideas and experience I have encountered. These serve as a track record for me and myself and for everyone else to learn. Trading and investments is a difficult tasks.

I lost quite a few grands, about $9,000 for my first year of noobish trading. That was after the 2008 financial crisis and it was some bull run to 2010, but I still lost. While I am trying to learn “everything”, yes you heard it, everything about trading and investments, I will jot down some of my experiences, and strategies as well.

Well the main key words for this site, manage money, already tells you that I am all about managing money. Afterall, no matter how daring and how much risk profile you want to take, Wall street, or the stocks market is just a random reactions of ups and downs. No repeated patterns no nothing, because if there is, even a 3 year old kid could understand.

With that bad experience, I’ve went deeper and deeper into this art or science. On the second year of my trading, I started building a small portfolio, instead of blindly trading. Reading up and understanding even more detailed into investment banks, financial institutions and hedge funds, I wanted to do what the big guys are doing.

While I go about managing my small little portfolio, hoping to beat the market and growing equity, by measuring my performance with the general market / hedge funds. With strategies such as statistical arbitrage, law of one price, portfolio rebalancing and management, risk management, long/short equities, high income stocks and dividends, and other strategies that I’ve tried, this is the outcome of a true results of a trader who trades his own personal account.

I hope I am able to grow my own funds through this never ending, tiring process of seeking The Truth, the Alpha.

Files under Hedging strategies, Managing Risk, Market Sentiments, Monthly Fund performance, Portfolio Management | Leave a Comment | No Comments »