Chartered Financial Analyst (CFA) Practice Exam Level 2

Which of the following will influence Active Return?

1. Market performance

2. Investment fees

3. Asset allocation return

4. Tax efficiency

The correct answer is: Asset allocation return

Active return is defined as the return of a portfolio above the benchmark return. Understanding the factors that influence active return is crucial for performance evaluation in active investment strategies. The active return can be decomposed into various components, and one critical component is the asset allocation return. Asset allocation return relates to the performance attributed to the strategic decisions about how much of the portfolio is allocated to different asset classes, such as stocks, bonds, and cash. These decisions significantly influence active return because they determine the level of exposure to various assets that can outperform the market benchmark. If a manager allocates more to asset classes that are expected to perform well relative to the benchmark, this can lead to a positive active return. Thus, effective asset allocation decisions are foundational to generating excess returns over the benchmark. While market performance can affect both active and passive return, it does not directly influence the active return since it is not a decision made by the portfolio manager. Investment fees, while important for overall returns, are also deducted from the total return rather than affecting active return directly. Tax efficiency relates to how returns are taxed and can impact an investor's net return but does not influence the active return itself, which focuses on the excess return generated by active management decisions. Therefore, asset allocation