Absolute Return: Definition, How It Works, & Examples
Absolute return is the total gain or loss of an investment over a specific time period, regardless of market conditions.
Absolute Return Explained
An absolute return is essential to understand when it comes to investing.
Unlike relative returns, which compare an investment’s performance to a benchmark or index, an absolute return focuses on the actual returns of the asset. It’s an unbiased, straightforward measure.
The beauty of absolute return is that it doesn’t judge an investment based on prevailing market trends or comparisons with other investments.
Whether the markets are soaring or plummeting, the absolute return only cares about one thing: the real, tangible gain or loss.
An absolute return is a clear and transparent way to evaluate investment performance, stripping away the often confusing layers of market context.
Investors often seek absolute return strategies to minimize risk and maximize profits, irrespective of market behavior. By focusing on the actual gains or losses, it helps investors make informed decisions that aren’t clouded by market noise.
Here are some key insights:
- Independent from Market Trends: Absolute returns remain unaffected by the general direction of the market. Whether the market is bullish or bearish, the absolute return represents the real change in an investment.
- Risk Management: By focusing on the actual performance, investors adopting absolute return strategies can often manage risk better.
- Transparency: The simplicity of absolute returns is one of its biggest strengths. There’s no need to dive into complex market comparisons; the returns are transparent and easy to understand.
An Example Of An Absolute Return
The concept of absolute returns might seem complex, but it boils down to something quite simple: what did you actually gain or lose from an investment? Let’s dissect this with an example.
Suppose you invest $10,000 in Company A. Over a one-year period, the stock market as a whole grows by 8%, but Company A’s stock grows by 12%. Your investment is now worth $11,200.
The relative return here would be 4%, as it’s 12% (Company A’s growth) minus 8% (the market’s growth).
However, the absolute return is 12%. It looks at the individual growth of Company A, disregarding what the market did. Your absolute gain is $1,200, and it doesn’t matter if the market went up, down, or stayed flat.
Absolute returns allow investors to measure the real return (success or failure) of their investments, granting them the clarity they need to make sound financial decisions.
Here’s another example:
Consider another scenario where you invest $10,000 in a fund aiming for absolute returns. The market has had a volatile year, with many stocks ending in negative territory.
Your fund manager, focusing on an absolute return strategy, maneuvers through this volatility and manages to achieve a 3% gain. You end the year with $10,300.
While many other investors may have faced losses due to market conditions, your absolute return focus ensured a gain, albeit a modest one. This gain is appreciated without considering the turbulent market environment.
Here are the differences between absolute returns and relative returns:
Absolute Vs Relative Returns
|Aspect||Absolute Returns||Relative Returns|
|Definition||Actual gain or loss of an investment.||Performance of an investment compared to a benchmark.|
|Focus||Individual investment performance.||Comparison with market trends or specific benchmarks.|
|Measurement||Calculated as the percentage change in value.||Difference between investment’s return and benchmark.|
|Market Dependency||Independent of market trends.||Dependent on market or benchmark performance.|
|Use||Risk management, clarity, and goal alignment.||Understanding how an investment performs against others.|
|Investor Perspective||Provides a clear picture of real gains or losses.||Offers a contextual view, comparing to market trends.|
What’s the difference between absolute return and relative return?
Absolute Return is the actual gain or loss of an investment, regardless of market trends. Relative Return, on the other hand, compares the investment’s performance to a benchmark or index.
Are absolute return funds safe?
Absolute return funds aim to produce a positive return irrespective of market conditions. While this may sound safe, it doesn’t mean they’re risk-free. Like all investments, they can vary in risk, and it’s essential to research thoroughly before investing.
Can I use absolute return strategies in my personal investments?
Absolutely! Whether a seasoned investor or just starting, understanding absolute returns can help you make informed decisions in your investment journey.
How do absolute return funds work?
Absolute return funds use various strategies to try to achieve a positive return. They may include short selling, leveraging, and diversification across different asset classes. The focus is on real gains, irrespective of market behavior.
Why would an investor choose an absolute return strategy?
Investors may opt for an absolute return strategy to aim for consistent returns and risk management. It’s a way to focus on actual gains, rather than being tied to the market’s ups and downs.