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Jensen's Alpha

Jensen's Alpha is a risk-adjusted performance measure that represents the average return on an investment above or below what was predicted by its risk level. It essentially tells you if an asset has 'beaten the market' after accounting for the risk taken. If the Alpha is positive, the asset has generated excess returns; if negative, it has underperformed relative to its theoretical risk profile.

The Security Market Line with two assets: one above the line, positive alpha, which beat what its risk predicted, and one below, negative alpha, which underperformed.
Jensen's Alpha is the distance between an asset's actual return and the return CAPM expects for its risk.

Unlike simple returns, Alpha isolates the "skill" of the asset selection from the "luck" of simply being exposed to a rising market. It is calculated by taking the actual return and subtracting the return that the asset "should" have earned based on the risk-free rate and its market sensitivity. A high Alpha combined with a low Beta is often considered the "Holy Grail" of investing, indicating superior returns with controlled market exposure.

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