The process of making alphas industry-neutral involves several steps. First, the exposures are segregated industry-wise. This means that the investments or assets are categorized based on the industry they belong to. Next, the capitalization-weighted alpha for each industry is calculated. The capitalization-weighted alpha is a measure of the performance of a portfolio where each component stock is weighted according to its market capitalization. This gives a more accurate representation of the industry's performance as it takes into account the size of the companies within the industry. After this, the industry average alpha is worked out. The industry average alpha is the average of the alphas of all the companies within a particular industry. Finally, the industry average alpha is subtracted from each alpha in that industry. This adjustment ensures that the alphas are industry-neutral, meaning that they do not contain any active bets on industries. Therefore, choice A accurately describes the process of making alphas industry-neutral.

Choice B is incorrect. This method suggests subtracting the industry average alpha from each alpha in that industry. However, it does not take into account the capitalization-weighted alpha for each industry which is a crucial step in ensuring that portfolios contain no active bets on industries.

Choice C is incorrect. This method suggests adding the industry average alpha to each alpha in that industry after calculating the capitalization-weighted alpha for each industry. However, this would not make alphas industry-neutral as required but rather increase their value by a constant factor (the average), which does not align with the process described.

Choice D is incorrect. Similar to choice B, this method also fails to consider the capitalization-weighted alpha for each industry and instead proposes adding an arbitrary constant (the average) to all alphas within an industry, which would distort their relative values and fail to achieve an active bet-free portfolio.

Things to Remember

• Alpha: Alpha is a measure of the active return on an investment, relative to a benchmark index. It represents the performance of a portfolio after adjusting for risk.