if we did not use words to make them”
Our industry is replete with words, expressions, and abbreviations that conjure up different meanings. My son, Chris, and I were on the phone with a prospective consulting client who said he’d arrange for us to meet the firm’s CIO. Knowing that the person we were speaking with was from the “IT” (information technology) side of the business, I wanted to confirm what he meant by CIO: Chief Investment Officer or Chief Information Officer. As I suspected, it was the latter.
When we use the term “alpha,” what do we mean? While some may be hesitant to ask, I generally do (though often the user of the word isn’t sure themselves). It can mean excess return, as in Portfolio Return minus Benchmark Return, or Jensen’s alpha, which is a arguably a risk-adjusted return measure which takes into consideration the portfolio’s beta (thus the excess return beyond what would have been predicted solely by beta).
Even “excess return” can be confusing, as some have used the term to mean, as just noted, Portfolio Return minus Benchmark Return, while others use it to mean Portfolio Return minus Risk-adjusted Return, which also goes by the name of Equity Risk Premium.
It is therefore helpful to specify the stipulative definition of the word or expression, which means the definition that specifies the meaning assigned by the person using it. Sometimes we may not know that there might be ambiguity, but there often is. I applaud the CFA Institutes’s inclusion of a glossary in the GIPS(r) standards as a way to clarify. As a past member of the committee that worked on the current version I’m quite familiar with the challenge of trying to decide if we use “should” or “must,” for example. And when dealing with individuals whose first language isn’t English, one must be careful to avoid even more confusion.
But don’t be afraid: when in doubt, ask!
Note: source for quote & “stipulative definition” concept: Measurement, Design and Analysis, by Pedhazur & Schmelkin