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What does the term "alpha" mean, and how does one interpret it? Thanks, J.S.
: Alpha is the first letter in the Greek alphabet. But in the context of mutual funds, the term alpha may not be as easy to learn as A, B, C. In order to understand alpha, oddly enough, it helps to first understand the concept of beta.
Beta is a volatility measure that tells investors how far a mutual fund will fall if the market takes a dive, and, conversely, how high the fund will rise if stocks starts to climb. A fund with a beta greater than 1 is considered more volatile than the market, while a beta of less than 1 means the fund is less volatile.
Say your fund has a beta of 1.15. That means it has a history of fluctuating 15% more than the
. If the market is up, the fund should outperform the index by 15%. If the market heads lower, the fund should fall by 15% more.
Alpha tells you how a fund is actually performing compared to its beta. A positive alpha is the extra return awarded to the investor for taking additional risk rather than accepting the market return (or beta). An alpha of 1.0 means the fund outperformed the market 1.0%. The greater the number, the greater the outperformance.
One note on beta: For funds that don't correlate well to the S&P, beta just doesn't tell you much. In those cases, fund-trackers like Morningstar may offer a best-fit index as well as an accompanying beta.
I have a quick question for you. What is a Eurodollar? Thanks, L.G.
I have an equally quick answer for you. Eurodollars are U.S. dollars deposited in banks outside the U.S.
The global floating-rate benchmark, three-month Libor, is the interest rate that major international banks charge on loans of eurodollars. Libor stands for London Interbank Offered Rate.
The three-month eurodollar futures contract listed on the Chicago Mercantile Exchange tracks three-month Libor and is among the world's most actively traded futures contracts. Because Libor hews closely to the fed funds rate, the eurodollar futures market is where most bets are made on the direction of U.S. short-term interest rates.
I've been hearing a lot about hedge fund regulation in the news. How come hedge funds aren't regulated like mutual funds? Best Regards, K.W.
Unlike mutual funds, hedge funds are not required to be registered under the Investment Company Act of 1940, which regulates companies that engage primarily in investing in securities of other companies. Among other things, the act requires disclosures about investment structure and financial condition when shares are offered to the public.
Since they don't have to adhere to the standards set by the investment act, hedge fund managers can maintain greater secrecy for their holdings and trades. That allows them to be free to adopt more, let's say, "flexible" strategies like using leverage or shorting stocks (hence the hedge connotation).
And that's the way they want it. Hedge funds aren't eager to establish regulations that would require them to disclose all of their activities.
Hedge funds can get away with not having these rules because they don't market their funds to the general public. They typically only have a limited number of accredited, high-net-worth individuals as stakeholders.
Because of the huge rise in the number of hedge funds in the U.S. (now more than 8,000), along with the worry that a failed hedge fund could bring down the entire market (remember Long Term Capital?), the
Securities and Exchange Commission
enacted a hedge fund registration rule in February. The move came over the protest of the hedge fund industry, which argued that the rule would give regulators unfettered powers to audit the funds' books.
In a big blow to securities regulators, however, a federal appeals court struck down this rule in June, saying it was too vague and "arbitrary.'' The appeals court ordered the SEC to re-examine the registration rule, saying that hedge funds are "notoriously difficult to define,'' according to a copy of the 19-page ruling.
Still, the SEC has estimated that about 90% of large hedge funds have complied with the new rule. But a number of well-known hedge funds, SAC Capital, for instance, have avoided registration by taking advantages of a number of loopholes in the rule that render them exempt from the registration requirement.