Not all SIPs are created equal: Why alpha matters

Summary: Avni and Ankita both invested in funds from the same category. Yet, one fund gave higher returns. Why is that so?

Avni had been investing in a flexi-cap fund for a year. Every month, like clockwork, a fixed sum left her account and entered her chosen fund via monthly SIPs.

She felt good about her discipline. But when she finally checked her fund’s performance after a year, she wasn’t so thrilled. The fund had delivered a return of around 10 per cent, much below the benchmark return of 16 per cent. That felt... underwhelming.

Interestingly, her friend Ankita had also been investing regularly in a flexi-cap fund – same monthly SIPs and for the same time frame. Yet, her fund had returned 18 per cent, nearly double what Avni earned.

Avni was perplexed. “How is that possible?”

“Did you check your fund’s alpha? It might be negative,” Ankita replied.

“What is alpha? And how do I find it?” Avni asked.

What exactly is alpha?

Alpha is a measure of how well a mutual fund has performed relative to its benchmark, after accounting for risk. In simple terms, it shows the value added (or lost) by the fund manager.

If your fund returns more than the benchmark, it has a positive alpha. If it lags behind, the alpha is negative.

Here’s the formula for calculating a fund’s alpha:

Alpha = Fund return – [Risk-free rate + Beta × (Benchmark return – Risk-free rate)]

Let’s now take the case of Avni’s and Ankita’s funds. Suppose both their funds had a beta (volatility of a fund with respect to the market) of 0.65 and a risk-free rate of 2 per cent.

Then, the alpha of Avni’s fund would be:

Alpha = 10 (fund’s return) - [0.02 + 0.65 (0.16 - 0.02)] = -0.0111 or -1.1 per cent

This means the fund underperformed its risk-adjusted benchmark by 1.1 percentage points.

On the other hand, the alpha of Ankita’s fund would be:

Alpha = 18 - [0.02 + 0.65 (0.16 - 0.02)] = 0.069 or 6.9 per cent

In simple words, Ankita’s fund outperformed its benchmark by 6.9 percentage points.

Why is alpha important?

Because not all equity funds are equal, even if they belong to the same category.

Both Avni and Ankita chose similar equity funds. However, it is clear that one fund manager made smarter moves than the other.

Thus, alpha helps you:

• Gauge a fund manager's skill
• Compare similar funds effectively
• Decide whether you're getting value for the fee you're paying

Final word: Don’t ignore alpha

When comparing mutual funds, many investors focus solely on absolute returns. But that’s not enough. Always ask: “How did my fund do compared to the market?”

That’s what alpha answers.

In Avni’s case, knowing this helped her understand that her fund manager hadn’t really delivered value.

So the next time you check your mutual fund returns, don’t just look at the number. Ask yourself: What's the alpha?

How can you find the alpha of your fund?

You don’t have to crunch the numbers yourself. Just head to the fund screener on Value Research Online to compare the alpha generated by different funds across various categories. The alpha values are based on the funds' performance over the last three years.

Tip: Don’t rely on one-year alpha alone. It can be noisy. For SIP investors like Avni and Ankita, longer-term alpha (3-5 years) offers a more reliable picture.

Also read: Understanding alpha in mutual funds

This article was originally published on July 20, 2025.