Understanding Absolute Return: A Comprehensive Guide

Absolute return can be defined as the return, i.e., absolute gain or loss, an investment generates over a specific period of time. The gain or loss is expressed as a percentage of the total investment.

How is Absolute Return Calculated?

Absolute return is calculated as follows:

Say, for example, an investor invested in real estate for $85,000. Two years later, the saleable value of the property rose to $105,000. Applying the above formula to the investment:

Here, the investor made an absolute return of 23.53% on the property.

Absolute Returns Strategy – Features

1. Positive returns

An absolute returns strategy aims at generating positive returns at all costs, regardless of whether the equity marketsCapital MarketsCapital markets are the exchange system platform that transfers capital from investors who want to employ their excess capital to businesses are rising or falling. It is the primary aim of the investment strategy that the investment portfolio is structured around.

2. Diversification of portfolio

The absolute returns strategy is centered around generating positive returns at all costs. Hence, it generally hosts a diversified portfolio with the intention of spreading risk, with different investment options generating returns in different ways for different periods of time.

3. Less volatility

Since absolute return funds are centered around generating positive returns only and are diversified in their structure, the overall risk of investment is spread across the different asset holdings in the portfolio. It, in turn, ensures less overall volatilityVolatilityVolatility is a measure of the rate of fluctuations in the price of a security over time. It indicates the level of risk associated with the price changes of a security. Investors and traders calculate the volatility of a security to assess past variations in the prices in the returns.

4. Actively adjustable to equity market movements

Absolute return funds are actively adjustable to equity market movements. It basically implies that when the equity market is on a decline, or showing negative movements, it shares a negative correlation with absolute return funds. Similarly, when the equity market is rising, or showing positive movements, it shares a higher correlation with absolute return funds.

5. Independent of benchmarks

Contrary to its opposite, relative return funds, absolute return funds are independent of benchmarks or market indexes. It means that the returns are in absolute terms and not relative to, i.e., in comparison to, a benchmark return or a market index.

Absolute Returns vs Relative Returns

While absolute returns are the returns, i.e., absolute gain or loss, an investment generates over a specific period of time, relative returns are the returns, i.e., relative gain or loss, an investment generates relative to, i.e., in comparison to, a benchmark or a market index.

Relative returns are generally considered more popular than absolute returns in the market. It is that investment returns, when assessed relative to a said benchmark or market index, reflect on the gain or loss made by the investor. However, absolute returns are considered an important indicator of how much an investor made or lost in absolute terms.

While the difference between the current market value and the purchase value (as a percentage of the total investment value) is the calculated absolute return of an investment, the relative returns of an investment are calculated as the difference between the absolute return of an investment and the benchmark (market performance index) of similar investments in the market.

Related Readings

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