Houston Metals Inc. has a small pension fund that is managed by a professional portfolio manager. All of the fund’s assets are invested in corporate equities. Last year, the portfolio manager realized a rate of return of 18%. The risk-free rate was 10% and the market risk premium was 6%. The portfolio’s beta was 1.2.
a. Compute the portfolio’s alpha.
b. What does the portfolio’s alpha imply about the manager’s performance last year?
c. What can the firm’s financial manager conclude about the portfolio manager’s performance next year?