Relative return is a measure of the return of an investment portfolio relative to a theoretical passive reference portfolio or benchmark. In active portfolio management, the aim is to maximize the relative return (often subject to a risk constraint). In passive portfolio management, the aim is to obtain a relative return as close to zero as possible, thereby reproducing the return of the theoretical reference portfolio. When the relative return is positive, the portfolio is said to outperform the benchmark. Conversely, when the relative return is negative, the portfolio is said to underperform the benchmark. Within passive portfolio management, the absolute value of the relative return is often called the tracking error, which is confusing since the tracking error is more generally defined as the standard deviation of the relative return.

Index fund An index fund (also index tracker) is a mutual fund or exchange-traded fund (ETF) designed to follow certain preset rules so that the fund can a specified basket of underlying investments.Reasonable Investor(s), Boston University Law Review, avail ...

s are the financial products that use passively managed portfolios. Many investors use the relative return measure to measure to evaluate the skill of the portfolio manager: if the relative return is positive, then the portfolio manager has skill. However, the relative return measure by itself is not sufficient to quantify how much skill a portfolio manager has, since the measure does not take into account the amount of risk that the portfolio manager has taken. Also, because investment returns are largely due to chance, a portfolio manager's historical performance is not a good indicator of skill. Funds that have historically out-performed the market, cannot be expected to outperform the market in future years. Juxtaposed with the relative return measure is the

absolute return The absolute return or simply return is a measure of the gain or loss on an investment portfolio expressed as a percentage of invested capital. The adjective "absolute" is used to stress the distinction with the relative return measures often use ...

measure, which is used to describe the return of the investment portfolio itself. In recent years, so-called absolute return strategies, that aim to always produce a positive absolute return regardless of the directions of financial market, have become popular. Contrary to popular opinion, it is not true that the relative return cannot be measured in a meaningful sense for absolute return strategies. After all, the neutral position of these portfolios is to be fully invested in cash without any other long or short positions. Thus, the

risk-free rate The risk-free rate of return, usually shortened to the risk-free rate, is the rate of return of a hypothetical investment with scheduled payments over a fixed period of time that is assumed to meet all payment obligations. Since the risk-free ra ...

is an appropriate benchmark to use for measuring the relative return of absolute return strategies.

References

{{DEFAULTSORT:Relative Return Investment

See also

References