alpha 36 vs risk in mutual funds

Alpha vs. Risk in Mutual Funds: A Deep Dive into Performance Metrics

As a finance expert, I often get asked how to measure mutual fund performance beyond simple returns. Two key metrics stand out: alpha and risk. While most investors focus on returns, understanding how a fund generates those returns—and at what cost—is crucial. In this article, I break down Alpha 36 (a specialized form of alpha) and compare it with traditional risk metrics like standard deviation and beta.

Understanding Alpha and Risk

What Is Alpha?

Alpha measures a fund’s performance relative to a benchmark. A positive alpha means the fund outperformed its benchmark after adjusting for risk. The formula for alpha is:

\alpha = R_p - (R_f + \beta \times (R_m - R_f))

Where:

  • R_p = Portfolio return
  • R_f = Risk-free rate
  • \beta = Beta (systematic risk)
  • R_m = Market return

What Is Alpha 36?

Alpha 36 is a variation that evaluates performance over a 36-month rolling period, smoothing out short-term volatility. It helps identify consistent outperformance rather than luck-driven spikes.

What Is Risk in Mutual Funds?

Risk isn’t just about losing money—it’s about volatility, drawdowns, and unpredictability. Common risk metrics include:

  1. Standard Deviation – Measures return variability.
  2. Beta – Indicates sensitivity to market movements.
  3. Sharpe Ratio – Risk-adjusted return (\frac{R_p - R_f}{\sigma_p}).

Comparing Alpha 36 and Risk

Why Alpha 36 Matters More Than Raw Returns

A fund might show high returns, but if those returns come with extreme volatility, they may not be sustainable. Alpha 36 filters out noise by focusing on longer-term consistency.

Example: Two Funds, Same Return, Different Alpha

FundAnnual ReturnAlpha 36Standard Deviation
A12%+2.518%
B12%-1.025%

Fund A has a positive Alpha 36, meaning it outperformed its benchmark consistently. Fund B has higher risk (standard deviation) and negative alpha, indicating it took more risk for the same return.

Risk-Adjusted Performance: The Sharpe Ratio Angle

The Sharpe Ratio helps compare funds with different risk levels. A higher Sharpe Ratio means better risk-adjusted returns.

Sharpe\ Ratio = \frac{R_p - R_f}{\sigma_p}

If Fund A has a Sharpe Ratio of 1.2 and Fund B has 0.8, Fund A is the better choice despite identical returns.

Case Study: Applying Alpha 36 and Risk Metrics

Let’s analyze two real-world mutual funds (hypothetical data for illustration):

Fund3-Year ReturnAlpha 36BetaStandard DeviationSharpe Ratio
X10%+1.81.112%1.4
Y11%-0.51.420%0.9

Observations:

  • Fund X has lower returns but better risk-adjusted performance (higher Alpha 36 and Sharpe Ratio).
  • Fund Y has higher returns but takes more risk (higher beta and standard deviation).

Mathematical Interpretation

If the risk-free rate is 2% and market return is 8%, Fund X’s alpha calculation would be:

\alpha_X = 10\% - (2\% + 1.1 \times (8\% - 2\%)) = 1.8\%

Fund Y’s alpha:

\alpha_Y = 11\% - (2\% + 1.4 \times (8\% - 2\%)) = -0.5\%

This confirms Fund X’s true outperformance.

Practical Implications for Investors

When to Prioritize Alpha 36 Over Risk Metrics

  • Long-term investors benefit more from Alpha 36 since it smooths out short-term fluctuations.
  • Risk-averse investors should focus on low standard deviation and high Sharpe Ratio.

When Risk Metrics Matter More

  • Short-term traders may prefer high-beta funds for market swings.
  • Aggressive investors might accept higher volatility for potentially higher returns.

Conclusion: Balancing Alpha and Risk

Alpha 36 helps identify skill-based performance, while risk metrics reveal how much uncertainty accompanies returns. The best mutual funds combine high Alpha 36 with manageable risk.

Scroll to Top