What is the difference between excess return and total return

Drawdowns or Market Drawdowns : A drawdown is a peak-to-trough decline during a specific period for an investment, trading account, or fund. A drawdown is usually quoted as the percentage between the peak and the subsequent trough.

Earnings per share EPS : How much profit a company has made per share within a given period. EPS is a fairly arbitrary number by itself, because the company can control the number of shares outstanding through splits and buybacks. ETF Exchange-Traded Fund : ETFs or exchange-traded funds are hybrid investment vehicles that can offer relatively low-cost and tax-efficient exposure to a variety of asset classes and investment strategies. Like traditional mutual funds, most ETFs invest in a diversified portfolio of stocks and bonds.

Unlike traditional mutual funds, ETFs trade on a stock exchange. The majority of ETFs are passively managed, which means they track an index.

That said, a growing minority of them are actively managed. Irrespective of whether they are tracking an index or delivering an active strategy, ETFs tend to have lower annual expenses relative to mutual funds. That said, because they trade like stocks, investors should account for transaction costs commissions, bid-ask spreads, and so on. ETFs are often lauded for their tax efficiency compared with traditional mutual funds.

There are two main reasons ETFs are often more tax-efficient. First, most ETFs are index funds. And index funds, especially large-cap index funds or total-market index funds that are weighted by market cap, have fairly low turnover.

Low turnover means fewer opportunities to realize gains when securities are sold from the portfolio. As such, ETFs tend not to have to directly sell positions from their portfolios to meet redemptions, which protects investors from taxable capital gains distributions. The primary benefit of ETFs from a tax perspective is that they can allow investors to defer the realization of capital gains taxes.

Investors in ETFs will still pay taxes on regular distributions of income, and they will also pay capital gains taxes when they sell an ETF for more than they paid for it. Also, some ETFs will distribute capital gains, though they tend to be less frequent and of lesser magnitude than those their mutual fund counterparts generate.

Fund of Funds: Funds that specializes in buying shares in other mutual funds rather than individual securities. Quite often this type of fund is not discernible from its name alone, but rather through prospectus wording i.

Hedge: An investment strategy to reduce risk of loss from price fluctuations of securities. Investors often try to hedge against inflation by purchasing assets such as gold or real estate that will rise faster than inflation. Mutual fund managers and pension fund managers often hedge their exposure to currency or interest rate risk by buying or selling futures or options contracts.

Information Ratio: Information ratio is a risk-adjusted performance measure. The Israelson method is an adjustment of the Information Ratio to take into account the inconsistency of the IR when excess returns are negative. Implied Volatility Risk Premium: Implied Volatility Risk Premium represents the compensation that investors earn for providing protection against unexpected market volatility.

Leverage: Seeking profit on an investment by using borrowed funds, margin accounts, or buying securities through rights, warrants or options. Large volume, blue-chip stocks like the banks are highly liquid securities. Shares in small companies with low volume activity are not considered liquid. High-level liquidity is considered a good feature for a security or a commodity.

Liquidity also refers to the ability of investors to convert securities into cash. Examples of liquid accounts include bank chequing accounts, passbook accounts, investment certificates, and treasury bills. It represents the maximum price a client is willing to buy a security, and the minimum price a client is willing to accept as a seller.

Actual fees thus represent a closer approximation of the true costs to shareholders. Market Order: An order to buy or sell a security immediately, at the best available price.

The majority of orders executed on the exchanges are market orders. Mutual fund: When you invest in a mutual fund, your money is pooled with that of other investors, and then it is managed by a group of professionals who try to earn a return by selecting stocks for the pool. One key advantage of funds is that they can be less volatile. Simple statistics says that a portfolio is going to experience less volatility than the individual components of the portfolio. After all, individual stocks can and sometimes do go to zero, but if a mutual fund held 50 stocks, it would be very unlikely that all 50 of those stocks become worthless.

The flipside of this reduced volatility is that fund returns can be muted relative to individual stocks. Select personalised content. Create a personalised content profile. Measure ad performance. Select basic ads. Create a personalised ads profile. Select personalised ads. Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors. Total return, when measuring performance, is the actual rate of return of an investment or a pool of investments over a given evaluation period.

Total return includes interest, capital gains , dividends, and distributions realized over a period. Total return accounts for two categories of return: income including interest paid by fixed-income investments, distributions, or dividends and capital appreciation , representing the change in the market price of an asset.

Total return is the amount of value an investor earns from a security over a specific period, typically one year, when all distributions are reinvested. For that reason, a fund with a beta of near 1 which indicates broad market exposure and volatility in line with the upward and downward movements of the benchmark might produce slightly negative excess returns. This is because total return includes fund expenses, so a performance similar to the benchmark would yield a slightly negative alpha after taking fees into account.

Partly on the back of volatile and risky global markets, the constant hunt for sources of excess return is behind the proliferation of new strategies, products and investment techniques. An offshoot of this is the rise of quantitative investing, which seeks to analyse data within a set of rules in order to identify market abnormalities and stock characteristics which offer the best risk-adjusted returns.

And since many strategies are short term in nature, the quant business needs to continually adapt and innovate in order to find the next source of alpha, thereby driving the development of the entire investment industry.

These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Financial Analysis How to Value a Company. Table of Contents Expand. What Are Excess Returns? Understanding Excess Returns. Riskless Rates. Key Takeaways Excess returns are returns achieved above and beyond the return of a proxy.

The riskless rate and benchmarks with similar levels of risk to the investment being analyzed are commonly used in calculating excess return. Alpha is a type of excess return metric that focuses on performance return in excess of a closely comparable benchmark. Excess return is an important consideration when using modern portfolio theory which seeks to invest with an optimized portfolio.

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This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Related Terms Sharpe Ratio Definition The Sharpe ratio is used to help investors understand the return of an investment compared to its risk. Jensen's Measure Jensen's measure, or "Jensen's alpha," indicates the portion of an investment manager's performance that did not have to do with the market.

What Is a Risk Premium?