Which performance measure specifically indicates the amount by which a portfolio's return exceeds the benchmark due to skill?

Which performance measure specifically indicates the amount by which a portfolio's return exceeds the benchmark due to skill?

• A. Alpha
• B. Beta
• C. R-squared
• D. Sharpe ratio

Answer: (A)

When evaluating whether a portfolio’s outperformance comes from the manager’s skill, alpha is the key idea. Alpha measures the portion of the return that cannot be explained by the portfolio’s exposure to the market (its beta). In other words, it captures value added by active management beyond what would be expected from market movements. A positive alpha indicates the manager has added skill-driven excess return; a negative alpha suggests underperformance after adjusting for risk. Beta shows how much the portfolio moves with the market, not the manager’s skill. R-squared tells how much of the return variation is explained by the benchmark, not the source of excess return. The Sharpe ratio reflects risk-adjusted performance, combining return and total risk, but not specifically the portion due to skill.

When evaluating whether a portfolio’s outperformance comes from the manager’s skill, alpha is the key idea. Alpha measures the portion of the return that cannot be explained by the portfolio’s exposure to the market (its beta). In other words, it captures value added by active management beyond what would be expected from market movements. A positive alpha indicates the manager has added skill-driven excess return; a negative alpha suggests underperformance after adjusting for risk.

Beta shows how much the portfolio moves with the market, not the manager’s skill. R-squared tells how much of the return variation is explained by the benchmark, not the source of excess return. The Sharpe ratio reflects risk-adjusted performance, combining return and total risk, but not specifically the portion due to skill.