Absolute return is a straightforward way to gauge how much an investment has grown or shrunk during a specific time frame. To evaluate your stocks or mutual funds, you must grasp this concept. What matters most is the percentage change. This figure shows investors that the value of their assets changes over time. The concept dates back to 1949. It was Alfred Winslow Jones who pioneered this approach in New York. Hedge funds evolved from his work. The popularity of these funds has grown over time. Attracting diverse investors, they have become a formidable investment force. Their unique selling point is maximizing profits regardless of market conditions. This strategy has proven particularly attractive in volatile markets, where traditional investment methods might struggle.
How Absolute Return Operates
When we talk about absolute return, we're referring to the real-world performance of an investment independent of any external benchmarks. Often known as the total return, it encapsulates the gains and losses an asset or portfolio has experienced. This approach is particularly useful because it gives a complete picture of an investment's journey – whether it's made money or lost it.
Absolute return is unique because it's not tied to the broader market's movements or specific comparison points. Whether the market is soaring or plummeting, the absolute return and relative return are about how the individual investment has fared on its terms. This measure is critical in understanding an investment's standalone success or failure, unswayed by the broader market's ups and downs.
Absolute return bond funds aim for positive returns regardless of market conditions. Absolute return helps investors understand their investment performance irrespective of market trends or benchmarks. This method allows investors to make informed financial decisions by evaluating investment performance more individually and targetedly.
Absolute Return Calculation
To calculate it, you need two essential pieces of information: the initial amount you invested and the current value of that investment. The process is straightforward. To determine the absolute return, a simple calculation involves just a couple of key figures: the original amount of the investment and its present value. The formula to find out the absolute return is as follows:
(Current value of the investment - original investment amount) / original investment amount x 100
This formula helps in understanding how much the investment has grown or declined in terms of percentage.
Example of Absolute Returns
The concept of absolute return is best understood through an example. Take the Vanguard 500 ETF, which, from 2007 to 2017, achieved a 150.15% return. In contrast, the S&P 500 returned 153.07% at the identical time. The Vanguard 500 Index ETF's relative return was -2.92%, slightly lower than the S&P 500 Index's absolute return of 4.00%. The difference between absolute and relative returns highlights the performance of an investment in isolation versus its performance compared to a benchmark or market index.
The Main Features of Absolute Return
1. Generating Positive Returns
The essence of an absolute return strategy is its focus on consistently producing positive outcomes. This approach doesn't hinge on the direction of the equity markets. Whether markets are climbing or declining, the central goal remains to create gains. This strategy forms the foundation of the investment portfolio, ensuring that regardless of market conditions, the aim is to achieve positive financial results. This consistent pursuit of gains is an absolute return asset management characteristic.
2. Portfolio Diversification
Diversification is a key element in the absolute return approach. The strategy minimizes risks by spreading investments across various asset types. This mix is carefully selected to ensure that different components contribute to overall returns in varying market scenarios. The strategy aims to achieve consistently positive outcomes by diversifying, making it a unique aspect of absolute and relative return approaches. This broad spectrum of investments helps manage risk and aim for steady returns over various periods.
3. Minimizing Volatility
One of the advantages of absolute return and relative return is their ability to reduce overall investment volatility. This is achieved through a diversified portfolio structure, which spreads risk across various assets. As a result, the funds tend to demonstrate lower volatility compared to more concentrated investment approaches. The focus is always on maintaining positive growth, irrespective of market fluctuations. This reduced volatility is a significant benefit for investors seeking stable returns.
4. Responsiveness to Equity Market Fluctuations
Absolute return funds exhibit a high degree of adaptability to changes in the equity market. These funds are designed to adjust their strategies in response to market movements. When the equity market declines, absolute return funds typically move inversely, and vice versa when the market rises. This adaptability is distinctive, differentiating absolute return funds from other investment types. Their ability to adjust based on market conditions is a key aspect of their strategy.
5. Benchmark Independence
A defining feature of absolute return funds is their independence from traditional benchmarks or market indexes. Unlike relative return funds, which measure success against specific benchmarks, absolute return funds aim for gains in absolute terms.
This approach means the performance is evaluated on its merits without comparing it to a market index or benchmark. This independence allows for a more focused approach to achieving positive returns, irrespective of market benchmarks.
Which One Is Better For You? Absolute or Relative Return?
The answer to this question varies based on personal investment goals and tastes.
Unlike relative return, absolute return and relative return don't involve comparing the performance of an asset to any other benchmark or standard. It stands alone as a measure of an investment's success or failure. The focus is solely on the asset itself – how much it has earned or lost in its own right, without any external comparisons. This makes it a very direct and clear method of assessing investment performance.
For investors seeking an authentic gauge of their investment's performance, uninfluenced by outside elements, absolute return is often the better choice. This method focuses solely on the investment's gains or losses. Conversely, investors interested in evaluating their investment's performance about a specific benchmark or market index might find relative return more useful. This approach compares the investment's performance against external standards, providing a context for its success or underperformance in the broader market.
