EdgeWare FastBreak Standard Version 5 - Manual (Page 89)

89
Alpha Ranking
Several users have asked for an option to trade funds based on “alpha” ranking.
Most investors are familiar with the “beta” parameter that measures fund volatility when
compared to an index. A common example of high beta funds is Rydex Nova. This fund
has a beta of 1.5 when measured against the S&P 500 index. The means that the fund
will move one and a half times as much as the index. For example, if the S&P moves up
1% then Nova will move 1.5%. The same is true on the downside where the moves are
also amplified.
Alpha is often described as the performance a fund would have if there is no change in
the index. For example, if the S&P did not change over a given time period, but the fund
increased by 5%, then alpha could be thought of as 5%. Note: Alpha can also have a
negative value.
A mutual fund manager can improve the fund performance using volatility (beta) by be-
ing a better stock picker (alpha) or a combination of volatility and good stock picking. A
potential advantage to a fund that has a lower beta and a high alpha is that the fund may
not drop as much during down markets as a fund that relies more on beta for perform-
ance. Note: In markets that are moving up strongly, high beta funds are usually the
place to be. However, if the market moves strongly to the downside, the high beta can
quickly do a lot of damage to fund performance.
The following chart was made using the annual return and beta (measured against the
S&P 500 Index) for a large group of growth funds:
Return vs Beta
(1988-1999)
10
15
20
25
30
35
0.8 1 1.2 1.4
Beta
Return, %/year