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.
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.
How Does Absolute Return Work?
This return works based on the current value of investment and initial investment amount. It is the difference between the current value and the initial value of an investment upon the initial value of the investment.
For computing returns over a term that is less than a year, this return is generally used. In the case of mutual fund investments, all that is required is the beginning value NAV and the ending value NAV (present NAV). The duration of the investment in the fund is irrelevant while computing these returns.
What is the Absolute Return Formula?
Absolute return is simple and easy to calculate. One needs only two values to estimate this return from an investment. They are the current value of the investment and initial investment. Below is the formula to estimate the absolute return:
Absolute return = ((Current value of the investment – Initial investment) / Initial investment) * 100
Let’s take an example of an investor Ms Vani Kumar who invested INR 1,50,000 in a mutual fund. The current value of the investment is INR 2,50,000. The absolute return for Ms Vani Kumar can be estimated using the above formula:
Absolute return = (250000-150000)/150000) *100
Absolute return = 66.66%
From her investment in a mutual fund, Ms Kumar has earned a return of 66.66%. However, this return doesn’t take into account the time period of the investment. Ms Kumar would’ve made this return in 5 years or 15 years. One cannot infer this from point to point returns. Hence mutual funds usually calculate annualized returns for any time period greater than one year.
Absolute Returns Strategy – Features
1. Positive returns
An absolute returns strategy aims at generating positive returns at all costs, regardless of whether the equity markets 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 volatility 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.
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.
Further, because the S&P 500 Index had an absolute return of 153.07% over the same period, absolute return differed from the relative return, which was -2.92%.