Total Risk Alpha
RFR + (ER[b] - ER[a])
STD[a] / STD[b]
Total Risk Alpha In A Nutshell
Total risk alpha measures the performance of an asset while comparing it to the benchmark. Now, there are two pieces to this, and they are total risk and alpha. Alpha is the return generated from an investment and should be monitored closely.
If you take a look at any mutual fund, odds are you will see that it is being compared to a benchmark in the industry. For example, the S&P mutual funds are compared with the S&P 500 as the benchmark.
Closer Look at Total Risk Alpha
Alpha is one of the first items many people ask when they are searching for an investment. It is important to understand the historical return over a period of time. Typically people invest in funds for quite some time, so they may be looking at the returns generated over a 3, 5, or 10 year period.
Then there is total risk, which is self explanatory. Total risk is how much you are risking for the potential returns of your investment. Risk needs to be kept in line because you can lessen certain risks such as company specific risk and duration risk. If you need help, an investing professional can certainly define these and help apply them to your current situation.
Now, total risk alpha compares the investment against the benchmark and it is important for you to understand what makes up the benchmark as well as the risk levels associated. This is a way to compare what you may invest in because sometimes the benchmark may be the better investment. Now each sector of the market will have its own unique risks and profile because the financial sector will be exposed to risks the food industry may not be exposed too.
Understanding risk and comparison against benchmarks is crucial and will hopefully give you clarity in your investing plans. Benchmarks are typically used with many products over different institutions, but be sure the benchmark is reputable. If you still are unsure, reach out to an investing community and bounce your questions off of them. Knowing what your investment is being compared against is crucial because you want to know your fund is accurately being managed and taken care of.