SIDC Module 12 Portfolio management and performance evaluation question: fund's Jensen's alpha

SIDC Module 12Portfolio management and performance evaluation

A fund returned 15% with a beta of 1.2. The risk-free rate was 5% and the market returned 12%. What is the fund's Jensen's alpha?

A 1.6%
B 3.0%
C 6.6%
D 10.0%

Show the answer and explanation

Answer: A. 1.6%

Jensen's alpha = Rp − [Rf + βp(Rm − Rf)] = 15% − [5% + 1.2 × (12% − 5%)] = 15% − 13.4% = 1.6%. Comparing the fund with the market, 15% − 12% = 3.0%, ignores the fund's higher beta. Deducting only the beta-scaled premium, 15% − 1.2 × 7% = 6.6%, forgets the risk-free intercept of the CAPM benchmark. 10.0% is the fund's excess return over the risk-free rate, 15% − 5%, with no adjustment for market risk at all. A positive alpha means the fund beat the return the CAPM requires for its systematic risk. Source: SIDC M12 Study Outline Topic 7.4 Evaluation of Investment Performance; Bodie, Kane and Marcus, Investments, chapter 'Portfolio Performance Evaluation'; CFA Institute, Portfolio Risk and Return: Part II (2026 Level I) (as at October 2026).

Common mistake

Comparing with the raw market return instead of the CAPM return for the fund's beta.

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