What is Absolute Return?
Absolute return is the return that an asset achieves over a specified period. This measure looks at the appreciation or depreciation, expressed as a percentage, that an asset, such as a stock or a mutual fund, achieves over a given period. Absolute return differs from relative return because it is concerned with the return of a particular asset and does not compare it to any other measure or benchmark.
Key Takeaways
- Absolute return is the return that an asset achieves over a certain period.
- Returns can be positive or negative and may be considered unrelated to other market activities.
- Absolute return, unlike relative return, does not make any comparison against other possible investments or to a benchmark.
How Absolute Return Works
Absolute return refers to the amount of funds that an investment has earned. Also referred to as the total return, the absolute return measures the gain or loss experienced by an asset or portfolio independent of any benchmark or other standard. Returns can be positive or negative and may be considered uncorrelated to other market activities.
Relative and Absolute Returns
In general, a mutual fund seeks to produce returns that are better than its peers, its fund category, and the market as a whole. This type of fund management is referred to as a relative return approach to fund investing. The success of the asset is often based on a comparison to a chosen benchmark, industry standard, or overall market performance.
As an investment vehicle, an absolute return fund seeks to make positive returns by employing investment management techniques that differ from traditional mutual funds. Absolute return investment strategies include using short selling, futures, options, derivatives, arbitrage, leverage, and unconventional assets. Absolute returns are examined separately from any other performance measure, so only gains or losses on the investment are considered.
The History of Absolute Return Funds
Alfred Winslow Jones is credited with forming the first absolute return fund in New York in 1949. In recent years, the absolute return approach to fund investing has become one of the fastest-growing investment products in the world and is more commonly referred to as a hedge fund.
Hedge Funds
A hedge fund is not a specific form of investment; it is an investment structured as a pool and set up as either a limited partnership or limited liability company (LLC). A hedge fund manager raises funds by working with outside investors. The manager uses the funds to invest based on a declared strategy involving only the purchase of long equities, such as common stock.
Hedge funds may specialize in specific areas, such as real estate or patents, and may also engage in private equity activities. While anyone may invest in a hedge fund, participants are traditionally accredited and sophisticated investors.
Example of Absolute Return
As a historical example, the Vanguard 500 Index ETF (VOO) delivered an absolute return of 150.15% over the 10-year period ending Dec. 31, 2017. This differed from its 10-year annualized return of 8.37% over the same period. Additionally, because the S&P 500 Index had an absolute return of 153.07% over the same period, the absolute return differed from the relative return, which was -2.92%.
Related Terms: Relative Return, Benchmark, Investment Fund, Mutual Fund, Portfolio.
