How do I check if my fund's alpha is genuine?

Checking Whether Your Fund's Alpha Is Genuine

There are six sequential tests. A fund must pass most of them to justify active fees.

Step 1 — Use the right benchmark

Compare your mid-cap fund to the Nifty Midcap 150, not the Nifty 50. Apparent outperformance vs. the wrong index is just the mid-cap risk premium — factor beta, not skill. ^[1]

Step 2 — Strip out factor beta

A fund's total return = beta return + alpha:

$$\alpha_a = r_a - \beta_a \cdot r_b$$

If the fund returned 16% and the Nifty returned 14% with a beta of 0.95:

$$\alpha_a = 16\% - (0.95 \times 14\%) = 2.7\%$$

But even this can be misleading. A mid-cap tilt, quality tilt, or momentum tilt will explain outperformance vs. Nifty 50 without any manager skill. The correct test controls for all relevant factors — only the residual is genuine alpha. ^{[3] [10]}

Step 3 — Check Active Share

Before calculating anything else, ask: is the fund actually making active bets?

$$AS = \frac{1}{2} \sum_{i} |w_{a,i} - w_{b,i}|$$

• Below 50%: Closet indexer — paying active fees for near-index returns. ^[5]
• Above 70%: Genuinely active, worth evaluating further. ^[1]

Step 4 — Calculate the Information Ratio

Alpha alone is insufficient. The question is: how much alpha per unit of active risk?

$$IR = \frac{E[\alpha]}{TE}$$

A fund beating Nifty by 3% with TE of 12% has IR = 0.25 — weak. The same 3% alpha with TE of 4% gives IR = 0.75 — genuinely skilled. ^{[6] [1]}

Step 5 — Check consistency

Did the fund beat its benchmark in at least 60% of rolling 3-year periods? A manager who only wins when their style factor is in favour is delivering factor beta, not skill. ^[1]

Step 6 — Clear the fee hurdle

Ask: is the IR high enough to justify the Expense Ratio — definition">expense ratio?

• IR of 0.4, expense ratio 1.5%: Marginal at best.
• IR of 1.2, expense ratio 0.8%: Worth paying for. ^[1]

Also ask: could you get the same factor exposure (quality, momentum, mid-cap) from a factor ETF at 0.20–0.30%? If yes, you may be paying active fees for passive factor beta. ^[10]

Quick mental model

$$IR \approx IC \cdot \sqrt{B}$$

A fund with genuine alpha has a manager with real forecasting skill (IC > 0) deployed across many independent bets (breadth B). A fund with high Active Share but poor IR is just taking concentrated, unskilled bets. ^[9]

Apply this → Go to Explore Funds, sort by 5-year Information Ratio, then cross-check the category benchmark and rolling consistency for any fund you hold.