Introduction - Total Portfolio Return, Mutual Fund Theorem and Alpha
Total Portfolio Return
Total return represents the actual rate of return of an investment or a pool of investments over a given evaluation period. It includes interest, capital gains, dividends and distributions realized over a given period of time.
Total return accounts for two categories of return: income and capital appreciation. Income includes interest paid by fixed-income investments, distributions or dividends. Capital appreciation represents the change in the market price of an asset.
Mutual Fund Theorem
Mutual Fund Theorem (MFT) is an investing theory, postulated by Nobel laureate James Tobin, that states that all investors should hold an identically comprised portfolio of "risky assets" combined with some percentage of risk-free assets or cash. A conservative investor would hold a higher percentage of cash, but would have the same basket of risky investments in his or her portfolio as an aggressive investor.
MFT came about as a result of the framework laid out by Harry Markowitz and his theories on how diversification limits portfolio risk. The viability of the mutual fund theorem has been questioned, because several important assumptions must be in place for the theorem to be proved. These include a lack of transaction costs and perfectly transparent markets.
- The Advantages Of Mutual Funds
- How Risk Free Is The Risk-Free Rate Of Return?
- The Capital Asset Pricing Model: An Overview
Alpha is one of the easiest terms to explain. Simply stated, alpha is often described to the value that a portfolio manager adds to or subtracts from an investment's return. Alpha is measured in direct relationship to the investment's benchmark.
A positive alpha of 1.0 means the fund has outperformed its benchmark index by 1%. Correspondingly, a similar negative alpha would indicate an underperformance of 1%. For both portfolio managers and investors, more alpha is always better.