Excess Returns


DEFINITION of 'Excess Returns'

Investment returns from a security or portfolio that exceed a benchmark or index with a similar level of risk. It is widely used as a measure of the value added by the portfolio or investment manager, or the manager's ability to "beat the market." Also known as alpha.

BREAKING DOWN 'Excess Returns'

For example, consider a large-cap U.S. mutual fund that has the same level of risk (i.e. beta = 1) as the S&P 500 index. If the fund generates a return of 12% in a year when the S&P 500 has only advanced 7%, the difference of 5% would be considered as excess return, or the alpha generated by the fund manager.

Critics of mutual funds and other actively-managed portfolios contend that it is next to impossible to generate excess returns on a consistent basis over the long-term, as a result of which, most fund managers underperform the benchmark index over time. This has led to the tremendous popularity of index funds and exchange-traded funds.

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