The three methods of refining alphas include trimming, scaling and neutralization. Trimming involves removing extreme values while scaling is performed to make the alphas have the proper scale for the portfolio construction process. The removal of biases from alphas is known as neutralization.

Things to Remember

• Alpha: Alpha is a measure of the active return on an investment, the return in excess of a benchmark index. It is often used to assess the skill of a portfolio manager.
• Trimming: Trimming involves removing extreme values or outliers from the alpha signal to improve its quality and reduce noise.
• Scaling: Scaling is the process of adjusting the magnitude of alphas to ensure they are suitable for the portfolio construction process.
• Neutralization: Neutralization refers to the process of removing biases from alphas, such as sector or style biases, to ensure that the alpha signal is truly independent and reflects stock selection skill.