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CFA Level I Exam · Benchmarking Returns

Calculating Benchmark and Active Returns for CFA Level 1

Updated 7 October 2026 · Fact-checked

Benchmark return is the return of the reference index or portfolio, often a weighted sum of component index returns. Active return is portfolio return minus benchmark return over the same period. Compute each return on the same basis, subtract, and keep the sign: positive means outperformance, negative means underperformance.

Understand Calculating Benchmark and Active Returns

A benchmark is a standard you compare a portfolio against. It might be a single index, such as a global equity index, or a blend, such as 60% equities and 40% bonds. The comparison tells you whether the manager added or lost value relative to a passive alternative.

The benchmark return for a blend is the weighted average of the component returns. Use the benchmark weights, not the weights the manager actually holds. Weights must sum to 100%.

Active return is the portfolio return minus the benchmark return for the same period. It is also called excess return relative to the benchmark. If the portfolio earns 8.0% and the benchmark earns 6.5%, active return is 1.5 percentage points.

The term tracking difference is used for the same gap, mainly for index funds and ETFs: fund return minus index return over a period. It is usually small and negative, because fees and trading costs reduce the fund's return. Tracking error is different. It is the standard deviation of the active returns over time, so it measures how variable the gap is, not how large it was in one period.

Active return can also be split by asset class: each segment's weight difference and return difference contribute. At Level I, the core skill is the simple subtraction done correctly, with consistent periods and gross or net treatment.

Key formulas to remember

Benchmark return (blend)
R_B = Σ (w_i × R_i)
Use benchmark weights w_i, which sum to 1. R_i is the return of each benchmark component.
Portfolio return (blend)
R_P = Σ (w_i × R_i)
Use the portfolio's actual weights and the portfolio's own segment returns.
Active return
Active return = R_P − R_B
Same period, same basis (both gross or both net). Result is in percentage points.
Tracking difference
Tracking difference = R_fund − R_index
A single-period or cumulative gap, not a standard deviation.
Tracking error
Tracking error = standard deviation of (R_P,t − R_B,t) over t
Measures variability of active returns. It is not the average active return.
Active return with geometric linking
Cumulative active return = [Π(1 + R_P,t) − 1] − [Π(1 + R_B,t) − 1]
Compound each series separately over the periods, then subtract. Do not add yearly active returns.

How to solve Calculating Benchmark and Active Returns questions

Use this order for any benchmark or active return question.

  1. 1Identify what is asked: benchmark return, portfolio return, active return, tracking difference or tracking error.
  2. 2Write down the period and check that all returns match it (annual with annual, same currency).
  3. 3If the benchmark is a blend, multiply each benchmark weight by its index return and sum.
  4. 4Compute the portfolio return from the given figure or from actual weights and segment returns.
  5. 5Subtract: active return = portfolio return minus benchmark return. Keep the sign.
  6. 6For several periods, link returns geometrically before subtracting, or compute active return per period if tracking error is asked.
  7. 7If tracking error is asked, take the standard deviation of the period active returns, not their mean.
  8. 8Check the answer is reasonable and in percentage points, then pick the matching option.

Quickest way: Weights times returns, then subtract

When to use it: Single-period questions with a blended benchmark and three numeric options.

  1. Compute the benchmark return in your head or on the calculator: sum of weight × return.
  2. Subtract it from the portfolio return.
  3. Check the sign first. If the portfolio beat the benchmark, drop any negative option.
  4. Options are ordered smallest to largest, so rough arithmetic is often enough to eliminate two choices.
  5. Watch for options that use the portfolio's weights instead of the benchmark's. That is the common trap.

Common mistakes in Calculating Benchmark and Active Returns

  • Using the portfolio's actual weights to compute the benchmark return

    Both weight sets appear in the question and look similar.

    Fix: Benchmark return always uses benchmark weights. Portfolio return uses portfolio weights.

  • Confusing tracking error with active return

    Both measure a gap from the benchmark and the names sound alike.

    Fix: Active return is a difference in returns. Tracking error is the standard deviation of those differences over time.

  • Adding yearly active returns to get a multi-year figure

    Subtraction feels simple, so students skip compounding.

    Fix: Compound the portfolio and benchmark returns separately, then subtract, unless the question asks for each year's active return.

  • Comparing a net-of-fee portfolio return with a gross benchmark without noting it

    Students ignore the basis of the numbers.

    Fix: Read which returns are net or gross. Indexes carry no fees, so a net fund return will understate skill against them. Follow the question's instruction.

  • Dropping the sign or mixing up the order of subtraction

    Rushing under time pressure.

    Fix: Always write portfolio minus benchmark. Underperformance is a negative number.

  • Reporting active return as a percentage of the benchmark return

    Students divide by the benchmark to get a relative figure.

    Fix: Active return is an absolute difference in percentage points unless the question defines a ratio.

Worked examples

Example 1

A portfolio is benchmarked to 60% Global Equity Index and 40% Global Bond Index. Over the year the equity index returned 10.0% and the bond index returned 4.0%. The portfolio returned 8.1%. What is the active return? A. −0.1%, B. 0.5%, C. 1.7%

Show the solution
  1. Benchmark return = 0.60 × 10.0% + 0.40 × 4.0%.
  2. 0.60 × 10.0% = 6.0%. 0.40 × 4.0% = 1.6%.
  3. Benchmark return = 7.6%.
  4. Active return = 8.1% − 7.6% = 0.5%.
  5. Option A is negative, but the portfolio beat the benchmark, so the sign is wrong.
  6. Option C is the swapped-weights trap. Using 40% equity and 60% bond gives a benchmark of 0.40 × 10.0% + 0.60 × 4.0% = 4.0% + 2.4% = 6.4%, and an active return of 8.1% − 6.4% = 1.7%. The benchmark weights are 60/40, so this is wrong.

Answer: B. Active return is 0.5 percentage points.

Example 2

An ETF returned 11.2% over a year. Its index returned 11.6%. In the same year, the ETF's monthly active returns had a standard deviation of 0.15% per month. What is the ETF's tracking difference for the year? A. −0.4%, B. 0.15%, C. 0.4%

Show the solution
  1. Tracking difference = fund return − index return.
  2. 11.2% − 11.6% = −0.4%.
  3. The 0.15% is the standard deviation of monthly active returns, which is the tracking error, so it is a distractor.
  4. Option C has the wrong sign, since the fund lagged the index.

Answer: A. The tracking difference is −0.4%.

Exam tips

  • Read the question for the word asked: active return, tracking difference or tracking error. They have different answers.
  • Eliminate options by sign first. It often removes one choice immediately.
  • Check whether weights given are benchmark or portfolio before multiplying.
  • If tracking error appears with period active returns, remember it is a standard deviation. Use the sample standard deviation unless the question says otherwise.
  • On the BA II Plus, compute weighted sums with chained keystrokes, for example 0.6 × 10 + 0.4 × 4 = 7.6, then subtract.

Practice questions from Benchmarking Returns

Calculating Benchmark and Active Returns in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Calculating Benchmark and Active Returns: frequently asked questions

What is the formula for active return?

Active return = portfolio return − benchmark return, for the same period and on the same basis. A positive result means the portfolio beat the benchmark. It is expressed in percentage points.

What is the difference between active return and tracking error?

Active return is the gap between portfolio and benchmark returns in a period. Tracking error is the standard deviation of those gaps across periods. A portfolio can have a high average active return and a low tracking error, or the reverse.

What is tracking difference?

Tracking difference is fund return minus index return over a period, often used for ETFs and index funds. It is typically negative because of fees and trading costs. It is not a measure of variability.

How do I calculate a blended benchmark return?

Multiply each component index return by its benchmark weight and add the results. The weights must sum to 100%. Use the benchmark weights, not the portfolio's actual allocation.