I am a little confused regarding the concept of excess returns.
For example, if my portfolio generates returns of 10% and my Treasury benchmark generates 3%, I would assume that excess returns is 10% - 3% = 7%. This means that I have beaten the market by 7% which is my excess returns
However, I am reading elsewhere that excess returns is a result of the portfolio’s performance, irrespective to Treasury performance. In other words, the 3% is a result of performance related to Treasuries and the 7% is purely related to the portfolio itself for a total return of 10%. If the Treasury return was 9% and the excess return was 1%, does that mean that most of my portfolio’s return was due to Treasury return.
Can someone shed some light with respect to this?
i may be wrong but i believe excesss return is measured against a benchmark. If your benchmark is treasury, then the excess return will be the return above 3%.
Nonetheless, if you have a market porftolio, it may have stocks and other assets other than treasury securities. Which should be measured against other benchmark that include other assets too.
Now, without knowing the weights of your portfolio its impossible to determine the effect of the treasury security in the overall portfolio, even if it has a 20% returns against 1% of all the other assets combined.
(95% x 1%) + (5% * 20%) = 0,95 + 1 = 1,95
Treasury share of total return = 1/1,95 = 51%
Yes, generally the excess return is the difference between the portfolio’s return and the benchmark return. Furthermore, the benchmark should be chosen to match the style of the portfolio; if you have a small cap equity portfolio, for example, a Treasury benchmark would be inappropriate, but a broad small cap index would be appropriate.