How is the active component of return defined?

The active component of return is defined as the difference between the portfolio return and the benchmark return. This concept is fundamental in performance measurement for investment portfolios, particularly in evaluating how well an investment manager has performed relative to a specified benchmark. Effectively, it shows the return generated by the portfolio that exceeds or falls short of the benchmark's return.

When calculating this active return, you take the actual return of the portfolio and subtract the return of the benchmark. A positive active return indicates that the investment manager has added value compared to the benchmark, while a negative active return suggests underperformance. This formula helps investors identify the effectiveness of their investment strategy compared to a passive approach based on a benchmark.

Other definitions provided do not accurately capture this relationship; for instance, options that include adding returns or subtracting portfolio returns from the benchmark do not yield a valid measure of active return. Thus, the correct definition underscores the importance of understanding how portfolio performance relates to established benchmarks in the context of active management.