DEFINITION of 'Trading Effect'

A measure of performance that examines the difference in returns between a bond portfolio and a chosen benchmark. This difference occurs as a result of short-term alterations in the portfolio's composition. The trading effect reveals whether trading activities benefited or hindered a portfolio's return.

BREAKING DOWN 'Trading Effect'

The trading effect serves as a way for investors to quantify a portfolio manager's performance. It answers the simple question of whether the manager (or investor) added value by making adjustments to the portfolio. If the benchmark, such as the Dow Jones Corporate Bond Index, outperforms the actively managed bond portfolio, then the manager subtracted value for the investor. If the bond portfolio earns more than the bond index, then the changes in portfolio composition have increased investor value, indicating a good management strategy.

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