Active return, in the context of finance and investment management, refers to the difference between the actual return on an investment portfolio and the return on a benchmark index. It is a measure used to evaluate the performance of an investment manager or fund by comparing their returns to a market or industry benchmark. Active return provides insight into the manager’s ability to generate excess returns above the benchmark.
Investors commonly utilize benchmarks such as stock market indices, such as the S&P 500, to gauge the overall performance of their investments. These benchmarks represent the average returns of a particular market, sector, or asset class. Active return, on the other hand, identifies the value added or subtracted by an investment manager through stock selection, sector allocation, or other active investment strategies.
To calculate active return, the returns of the portfolio and the benchmark are compared over a specific time period. The difference between the two returns reveals the manager’s ability to outperform or underperform the benchmark. A positive active return indicates that the manager has generated higher returns than the benchmark, while a negative active return suggests underperformance.
Active return is an essential metric for both individual and institutional investors, as it helps them assess the skill and performance of investment managers or funds. Positive active returns demonstrate the manager’s ability to identify opportunities and generate excess returns, which may justify the associated fees and encourage further investment. Conversely, consistent negative active returns may raise concerns about the manager’s capabilities, potentially leading to investor withdrawals.
Active return should not be confused with total return, which measures the change in the value of an investment over a specific period, including both price appreciation and any income generated, such as dividends or interest. Total return provides a comprehensive view of an investment’s performance, whereas active return solely focuses on the difference between the portfolio’s return and the benchmark’s return.
Active return is influenced by various factors, including the investment manager’s skill, expertise, investment strategy, and market conditions. Skilled managers who possess strong analytical capabilities, deep industry knowledge, and disciplined investment processes may have a higher probability of generating positive active returns. Furthermore, favorable market conditions, such as bull markets or specific sector trends, may enhance the potential for positive active returns.
In summary, active return measures the excess or shortfall of an investment portfolio’s returns relative to a benchmark, reflecting the value added or subtracted by an investment manager through active investment strategies. It plays a crucial role in evaluating the performance of investment managers and funds, helping investors determine whether the fees paid for active management are justified. By considering active return alongside other performance metrics, investors can make informed decisions about their investment strategies and allocations.
This glossary is made for freelancers and owners of small businesses. If you are looking for exact definitions you can find them in accounting textbooks.