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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  1. How do you calculate the excess return of an ETF or indexed mutual fund?

    For exchange-traded funds (ETFs), the excess return should be equal to the risk-adjusted (or beta) measure that exceeds the ... Read Full Answer >>
  2. Can mutual funds only hold stocks?

    There are some types of mutual funds, called stock funds or equity funds, which hold only stocks. However, there are a number ... Read Full Answer >>
  3. How do mutual funds compound interest?

    The magic of compound interest can be summed up as the concept of interest making interest. On the other hand, simple interest ... Read Full Answer >>
  4. Do mutual funds pay interest?

    Some mutual funds pay interest, though it depends on the types of assets held in the funds' portfolios. Specifically, bond ... Read Full Answer >>
  5. Why have mutual funds become so popular?

    Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>
  6. Do mutual funds pay dividends?

    Depending on the specific assets in its portfolio, a mutual fund may generate income for shareholders in the form of capital ... Read Full Answer >>

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