What does the Incremental return contribution formula calculate?

The Incremental return contribution formula is designed to calculate the additional return that a particular asset category contributes to a portfolio based on its performance relative to a benchmark, often the risk-free rate. By using asset category weights and the return differences between that category and the risk-free rate, this formula quantifies how much an additional unit of investment in an asset category has increased the overall return of the portfolio beyond what could be earned from a risk-free investment.

Specifically, the formula takes into account not just the returns of the asset categories themselves, but how those returns compare to the opportunity cost represented by the risk-free rate. This approach helps in assessing the effectiveness of the asset allocation strategy in enhancing portfolio returns.

When looking at other choices, while some may describe different components or layers of return calculation, they do not capture the core function of the Incremental return contribution formula, which revolves around measuring performance relative to the risk-free rate. The other options may address returns or categories of assets but lack the focus on the specific comparison mechanism inherent in the incremental return concept.