Final answer:
To determine which factor contributes the most to active return, one can analyze factors such as asset allocation, stock selection, market timing, and currency exposure. Attribution analysis can be used to evaluate the impact of each factor on active return.
Step-by-step explanation:
Active return refers to the investment return achieved by an investment manager compared to a benchmark index. To determine which factor contributes the most to active return, you can analyze various factors such as asset allocation, stock selection, market timing, and currency exposure.
One way to evaluate the contribution of each factor is by using attribution analysis.
Asset allocation: This factor refers to the allocation of investments across different asset classes, such as stocks, bonds, and commodities. It can have a significant impact on active return as different asset classes have varying performance.
Stock selection: This factor focuses on the selection of individual stocks within a given asset class. Skilled stock selection can contribute to active return by outperforming the benchmark index.
Market timing: Market timing refers to the ability to predict market trends and adjust the portfolio accordingly. Proper market timing can enhance active return by taking advantage of market movements.
Currency exposure: For global portfolios, the fluctuation in currency exchange rates can impact the investment returns. Managing currency exposure effectively can help contribute to active return.
In conclusion, to determine which factor contributes the most to active return, it is essential to conduct attribution analysis and evaluate the impact of asset allocation, stock selection, market timing, and currency exposure.