What Is Absolute Return?
Let me explain absolute return directly: it's the return an asset achieves over a specified period, looking at the appreciation or depreciation as a percentage for something like a stock or mutual fund.
You should know that absolute return stands apart from relative return because it focuses only on the asset's own performance, without comparing it to any other measure or benchmark.
Key Takeaways
- Absolute return is the return an asset achieves over a certain period.
- Returns can be positive or negative and may be unrelated to other market activities.
- Absolute return, unlike relative return, avoids comparisons to other investments or benchmarks.
How Absolute Return Works
Absolute return is about the funds an investment has earned, also known as total return, measuring the gain or loss of an asset or portfolio without tying it to any benchmark or standard.
You can expect returns to be positive or negative, and they often don't correlate with other market activities.
Relative and Absolute Returns
In general, a mutual fund aims for returns better than its peers, category, or the overall market—this is the relative return approach, where success comes from comparing to a benchmark or industry standard.
An absolute return fund, however, seeks positive returns using techniques different from traditional mutual funds, such as short selling, futures, options, derivatives, arbitrage, leverage, and unconventional assets.
I want you to understand that absolute returns stand alone, considering only the investment's gains or losses without other performance measures.
The History of Absolute Return Funds
Alfred Winslow Jones gets credit for creating the first absolute return fund in New York in 1949.
In recent years, this approach has become one of the fastest-growing investment products globally, commonly known as a hedge fund.
Hedge Funds
A hedge fund isn't a specific investment type; it's structured as a pool, often a limited partnership or LLC.
The manager raises funds from outside investors and invests based on a declared strategy, which might involve only long equities like common stock.
Hedge funds can specialize in areas like real estate or patents and may engage in private equity, with participants typically being accredited and sophisticated investors.
Example of Absolute Return
Take the Vanguard 500 Index ETF (VOO) as a historical example: it 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.
Since the S&P 500 Index had an absolute return of 153.07% in that time, the absolute return for VOO contrasted with its relative return of -2.92%.
