If you hang around investment people long enough you’re bound to hear them talk about the quest for alpha. There’s even a popular website devoted to investment news and information called Seeking Alpha (www.seekingalpha.com). But what is alpha?

Alpha is a risk-adjusted measure of a portfolio manager’s performance. In other words, it represents the amount of portfolio returns attributable to the portfolio manager’s decisions above and beyond that of normal market fluctuations. So when an investor is saying they’re looking for alpha, they really are saying that they’re searching for an investment professional that can provide positive returns by her decision-making ability.

Of course, there is a formula for calculating alpha, and many folks get into that sort of thing when analyzing their portfolios. Honestly, calculating alpha is beyond the scope of this article, I just wanted you to have some idea what people are talking about when they throw out the term.

The important thing to know is that alpha provides a metric with which you can evaluate the risk-adjusted value added by a portfolio manager. It’s important to take this metric into consideration when thinking about the fees paid to the manager. Were the returns, in the sense of alpha, worth the fees? Alpha can tell you if the manager is taking undue risk for the amount of returns you see. If your fees are high, and your risk is high for the amount of return you receive, you may want to shop around for a more conservative manager who can provide the same level of returns for much less risk.

Evaluating the alpha of a portfolio manager has been compared to reading up on the fuel economy of different vehicles before deciding which one to purchase. And I think this is a good analogy; after all, since alpha gauges risk-adjusted returns it gives you a good idea just how efficient your investment professional is.