5 diversified equity funds that have delivered the highest alpha

For investors seeking returns that consistently beat benchmark indices, alpha is one of the most important measures of a fund's performance. It reflects a fund manager's ability to generate excess returns above market returns, making it a key indicator of active management success.

Here are the top five mutual funds with the highest alpha ratios, showcasing schemes that have delivered benchmark-beating performance.

What is alpha?

Alpha measures how much returns a fund has generated over the benchmark index returns, let's say the Nifty 50. It simply tells you the efficiency of a fund manager in generating excess returns after adjusting for risk (beta).

The baseline number for alpha is 0, which means that the fund has delivered the same return as the benchmark index in a specific period. If the alpha is greater than 0, then it means the fund has outperformed the benchmark index. A negative alpha highlights the underperformance.

Assume an X equity mutual fund scheme uses the Nifty 50 as its benchmark index. During a year, the Nifty 50 delivered a return of 9%, while the X equity fund generated 13% returns. In this case, the fund has created an alpha of 4%, meaning it has outperformed its benchmark by an additional 4%.

Alpha also highlights a fund’s ability to protect investors during market downturns. If the Nifty 50 declined by 14% in a year but the X fund fell by only 11%, the scheme has still performed relatively better than the benchmark by 3%.

Why is alpha important to consider in equity funds?

In equity funds, fund managers actively make stock selection and portfolio allocation decisions to generate returns higher than the broader market. However, debt funds focus more on fixed-income allocation strategies, while hybrid funds maintain a mix of equity and debt exposure.

Therefore, alpha becomes one of the most important metrics for equity funds, as it measures a fund manager’s ability to outperform the benchmark through active stock picking and portfolio management.

Top 5 equity funds by highest alpha

Here is the list of the top 5 equity funds by highest alpha that have outperformed their benchmark index:

Key points to know about alpha

Here are a few points or myths you should know about alpha:

Two funds can have the same returns, but do not have the same alpha

Two mutual funds may generate similar returns, but that does not mean they will have the same alpha. This is because alpha measures not only returns, but also the level of risk taken to generate those returns.

A fund achieving returns with lower risk may generate higher alpha compared to another fund that takes significantly higher risk to earn the same return.

For example, consider two equity funds, Fund A and Fund B. Both funds generated a return of 15% during a particular year, while their benchmark index delivered 10%.

However, Fund A achieved this return with a beta of 0.8, whereas Fund B had a beta of 1.4, indicating that Fund B took much higher market risk.

For Fund A, the expected return based on beta would be 8% (0.8 × 10%). Since the actual return was 15%, the fund generated an alpha of 7%.

For Fund B, the expected return would be 14% (1.4 × 10%). Since the actual return was 15%, the alpha would be only 1%. This means that Fund A is better as it has generated the returns while taking relatively lower risk compared to Fund B.

Alpha is backward-looking

Alpha is a backward-looking measure and should not be treated as a guarantee of future performance. Like other metrics used in portfolio analysis, alpha is calculated using a fund’s historical returns and past market behaviour.

As a result, a fund that has generated high alpha in the past may not necessarily continue to outperform in the future.

Negative alpha does not mean negative returns

Negative alpha does not mean that a fund has generated negative returns. It simply means that the fund has underperformed its benchmark after adjusting for risk.

Let's say an equity fund's benchmark index is the Nifty 50. During a particular year, the Nifty 50 delivered a return of 12%, while the fund generated a return of 11.6%. Although the fund has earned positive returns for investors, it has slightly underperformed the benchmark by 0.4%, resulting in a negative alpha.

Disclaimer: This is purely for educational/ informational purposes and should not be taken as any sort of investment advice. Always consult a SEBI-registered advisor before making any investment decisions.