Excess Returns

Loading the player...

What are 'Excess Returns'

Excess returns are 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.

RELATED TERMS
  1. Alpha

    Alpha is used in finance to represent two things: 1. a measure ...
  2. Alpha Generator

    Any security that, when added to an existing portfolio of assets, ...
  3. Portable Alpha

    A strategy in which portfolio managers separate alpha from beta ...
  4. Benchmark

    A standard against which the performance of a security, mutual ...
  5. Active Risk

    A type of risk that a fund or managed portfolio creates as it ...
  6. Portfolio Manager

    The person or persons responsible for investing a mutual, exchange-traded ...
Related Articles
  1. ETFs & Mutual Funds

    What are Excess Returns?

    Excess returns are investment returns that exceed a benchmark or index with similar risk.
  2. ETFs & Mutual Funds

    5 Ways To Measure Mutual Fund Risk

    These statistical measurements highlight how to mitigate risk and increase rewards.
  3. Investing

    A Deeper Look At Alpha

    The Jensen index helps investors compare realized returns to what should've been achieved.
  4. ETFs & Mutual Funds

    Alpha and Beta for Beginners

    An in-depth look at what alpha and beta are and what they measure.
  5. Trading

    Bettering Your Portfolio With Alpha And Beta

    Increase your returns by creating the right balance of both these risk measures.
  6. Trading

    Measuring And Managing Investment Risk

    Risk is inseparable from return. Learn more about these measures and how to balance them.
  7. ETFs & Mutual Funds

    Pursuing Alpha In A Well-Diversified IRA

    This strategy is not as complex as some investment gurus would like you to believe.
  8. ETFs & Mutual Funds

    Understanding Volatility Measurements

    How do you choose a fund with an optimal risk-reward combination? We teach you about standard deviation, beta and more!
  9. Managing Wealth

    More Ways to Evaluate Portfolio Performance

    The Jensen measure is another tool investors use to include risk when measuring portfolio performance.
  10. Managing Wealth

    Measure Your Portfolio's Performance

    Learn three ratios that will help you evaluate your investment returns.
RELATED FAQS
  1. How do you calculate the excess return of an ETF or indexed mutual fund?

    Read about how to calculate and interpret the expected return generated by an exchange-traded fund (ETF) and an indexed mutual ... Read Answer >>
  2. What is the relationship between alpha, beta, and r-squared when analyzing a fund?

    I'm curious about alpha, beta, and r-squared. I have researched funds where the fund outperforms the index, but the alpha ... Read Answer >>
  3. Is alpha the best risk measure?

    Read about some of the strengths and weaknesses of alpha, a popular risk-adjusted performance indicator based on modern portfolio ... Read Answer >>
  4. What metrics should I use to evaluate the risk return tradeoff for a mutual fund?

    Understand the key metrics used to analyze mutual funds and how investors can use each measurement to determine the risk-reward ... Read Answer >>
  5. What is the difference between the Sharpe ratio and alpha?

    Use alpha and the Sharpe ratio to evaluate mutual funds by comparing their risk-adjusted returns. Learn what modern portfolio ... Read Answer >>
  6. What's the difference between an index fund and an actively managed fund?

    Learn the difference between actively-managed funds and index funds. Explore the risks and benefits associated with each ... Read Answer >>
Hot Definitions
  1. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  2. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  3. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  4. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  5. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  6. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
Trading Center