Jensen's Alpha, developed by Michael Jensen in 1968, is a risk-adjusted performance measure that quantifies the excess return generated by a portfolio or fund above what would be predicted by the Capital Asset Pricing Model (CAPM) — given the fund's beta (market risk exposure) and prevailing market returns. It is calculated as: Jensen's Alpha = Actual Portfolio Return – [Risk-Free Rate + Beta × (Market Return – Risk-Free Rate)]. A positive Jensen's Alpha indicates that the fund manager has generated genuine skill-based returns above and beyond what pure market exposure would have produced. A negative alpha indicates underperformance relative to risk-adjusted expectations. Unlike the Sharpe Ratio (which measures return per unit of total risk), Jensen's Alpha specifically isolates the value added by active management decisions from market-driven returns. In Indian mutual fund performance evaluation, Jensen's Alpha is used by sophisticated investors and pension fund trustees to assess whether actively managed equity funds have genuinely outperformed the Nifty 50 benchmark after adjusting for their market risk exposure — rather than simply riding market beta during a bull phase. A large-cap equity fund with high positive Jensen's Alpha consistently over multiple market cycles provides compelling evidence of genuine fund manager skill worth the premium expense ratio charged over passive index alternatives.
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