What is the formula for making an alpha benchmark neutral?

To achieve an alpha benchmark neutral position, the correct approach involves taking the original alpha and adjusting it by subtracting the product of the stock's beta and the benchmark's alpha. This adjustment is necessary because it aligns the stock's performance with the benchmark's performance, thereby isolating the stock’s specific return relative to the benchmark.

The concept of alpha here refers to the excess return of an investment relative to the return of a benchmark index. When you account for the beta, you are taking into consideration the stock's sensitivity to market movements. If a stock has a high beta, it means its returns are more sensitive to changes in the market compared to a stock with a low beta. Therefore, adjusting the original alpha by subtracting the product of the stock's beta and the benchmark's alpha effectively neutralizes the effect of market movements on the alpha, allowing for a clearer comparison of the stock's performance.

In the context of performance evaluation, maintaining a benchmark-neutral alpha is essential for identifying true managerial skill or unique asset performance that is independent of market influences. This method provides a more accurate picture of a stock's performance beyond what can be explained by its correlation with the benchmark. Understanding this relationship is key for portfolio management, as it aids in making better investment