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Jensen’s alpha, also referred to as ex-post alpha, essentially measures how much extra a portfolio has earned above the return predicted by the capital asset pricing model (CAPM). This ratio was developed by American economist Michael Jensen in 1968. Mathematically, the Jensen’s alpha is calculated as follows:

Jensen’s alpha = R(i) - (R(f) + B x (R(m) - R(f)))

Where

• R(i) = the realized return of the portfolio or investment
• R(m) = the realized return of the appropriate market index
• R(f) = the risk-free rate of return for the time period
• B = the beta of the portfolio of investment with respect to the chosen market index

A positive Jensen’s alpha indicates that managers of the fund, through careful stock selection, have been able to extract higher returns than the market. Moreover, an investor should also look at the return a fund has generated compared to the risk involved. This is because investors need to be aware of a properly calculated measure of total return from an investment against the inherent risks involved.

3 Best Choices

Also known as the Jensen's Performance Index, Jensen’s alpha measures the return of an investment compared to its expected risk-adjusted return. We have, thus, selected three mutual funds carrying a Zacks Mutual Fund Rank #1 (Strong Buy) that are poised to gain from such factors. Moreover, these funds have encouraging three and five-year returns.

Additionally, the minimum initial investment is within $5000 and each of these funds has a high three-year alpha. A positive alpha indicates that the portfolio manager was able to earn substantial returns compared to the additional risk taken over the entire period of investment.

We expect these funds to outperform their peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance but also on the likely future success of the fund.

The question here is: why should investors consider mutual funds? Reduced transaction costs and diversification of portfolio without several commission charges that are associated with stock purchases are primarily why one should be parking money in mutual funds.

AB Large Cap Growth Fund Class K (ALCKX - Free Report)  seeks long-term capital appreciation, and invests in equity securities of a limited number of large, carefully selected, high-quality U.S. companies. The fund normally invests the lion’s share of its assets in common stocks of large-cap companies. However, at times, the fund may invest in shares of exchange-traded funds instead of making direct investments in securities.

This Large Cap Growth product has a history of positive total returns for more than 10 years. 

ALCKXhas an annual expense ratio of 0.96%, which is below the category average of 1.04%. The fund has three and one-year returns of 18.4% and 30%, respectively. ALCKXhad an alpha of 7.24 in the last three years.

Lord Abbett Growth Leaders Fund Class F (LGLFX - Free Report) aims for capital appreciation. The fund primarily invests in equity securities of both domestic and foreign companies across all market capitalization ranges that the portfolio management team believes have above-average, long-term growth potential.

This Large Cap Growth product has a history of positive total returns for over 10 years.

LGLFXhas an annual expense ratio of 0.68%, which is below the category average of 1.04%. The fund has three and one-year returns of 70.9% and 30.3%, respectively. LGLFXhad an alpha of 16.98 in the last three years.

Fidelity Select Technology Portfolio (FSPTX - Free Report) fund aims for capital appreciation. The fund invests primarily in equity securities, especially common stocks of companies that are engaged in offering, using, or developing products, processes, or services that will provide or will benefit significantly from technological advances and improvements.

This Sector-Tech product has a history of positive total returns for more than 10 years.

FSPTX has an annual expense ratio of 0.71%, which is below the category average of 1.24%. The fund has three and one-year returns of 31.1% and 63.7%, respectively. FSPTX had an alpha of 12.13 in the last three years.