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Expected Return is the return on an asset that is baked-in to market expectations at the present time. An active manager will compare expected return to forecast return when deciding whether an asset is cheap or expensive. This is typically derived by multiplying an asset's beta (see CAPM) by the expected return on the Market.
Synonyms: consensus return, implied return, equilibrium return
For context, it helps to think of three timeframes in investments: past, present and future. Because most investors can't fathom how to set expected returns on their own, they use past returns. When this is input as the numerator in a mean-variance optimization (MVO) for example, the results are biased for what happened in the past which isn't a good way to go about investing.
CAPM offers a way to see what is baked into current expectations for an investment, thereby setting an expected return. From there, an active investor who forecasts a different return can position the portfolio to benefit from this mispricing.
Pam: The stock had a beta of 2, but then
diversified. So that can't be a valid expected return.
Eve: I agree, run it through the 3-factor model. Jeez, look at us, now we sound like quant geeks.
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