Definition
The term active return refers to the gain or loss on an investment portfolio as a result of active management decisions. A fund's active return is the percentage gain or loss relative to a benchmark index.
Calculation
Active Return = Return of Portfolio - Return of Index
Where:
Return of Portfolio is the annual return achieved by an actively managed mutual or exchange traded fund (ETF).
Return of Index is the annual return achieved by an index fund such as the S&P 500.
Explanation
Also known as excess return, active return refers to the portion of an investment's gain or loss that can be attributed to the decisions made by an active portfolio manager. This metric does this by removing the investment's return that can be attributed to the overall market's movement. If the fund is able to achieve returns in excess of the market index, it will have a positive active return. If the fund underperforms relative to the market index, it will have a negative active return.
It is important for the investor to know the index used when benchmarking the active return of a fund. For example, a fund that attempts to outperform technology stocks might underperform relative to the S&P 500, and still return a positive active return relative to a technology index such as the NASDAQ Composite.
Example
Fund A is an actively managed technology mutual fund, which provided its investors with a return of 12.3% last year. The objective of the fund is to beat the performance of the NASDAQ Composite Index, which had a total return of 15.6%. The active return of Fund A would be calculated as:
= 12.3% - 15.6%, or -3.3%
Related Terms
The term active management refers to a portfolio manager that makes investments in an attempt to outperform a benchmark index. Active managers will use research reports, as well as pull from their experiences, when making investment decisions.
Moneyzine EditorNovember 6th, 2024- The term passive management refers to a portfolio manager that makes investments in an attempt to replicate the returns of a benchmark index. Passive managers do not use research reports when making investment decisions, they follow a pre-defined strategy that involves keeping the fund's assets in-line with the index they are mirroring.Moneyzine EditorNovember 6th, 2024
- The term tracking error refers to a measure that allows an investor to understand how close a fund follows its benchmark index. Tracking error is the standard deviation of the difference between the return of a mutual fund, or exchange traded fund, and its benchmark index.Moneyzine EditorSeptember 21st, 2023
