What Is “Absolute Return” in Investing and Portfolio Management?

The term “absolute return” refers to the total return an investment generates over a specific period, independent of any benchmark or market index. Unlike relative return, which measures performance compared to a market standard (such as the S&P 500), absolute return focuses solely on the actual gains or losses an investment produces.

Absolute return strategies are commonly used in hedge funds, mutual funds, and alternative investments, as they aim to deliver positive returns in all market conditions—whether the stock market is rising, falling, or moving sideways.

Understanding “Absolute Return” vs. “Relative Return”

To fully grasp the significance of absolute return, it’s essential to distinguish it from relative return:

• Absolute Return: Measures the actual percentage gain or loss of an investment, regardless of market conditions.
• Relative Return: Compares an investment’s performance to a benchmark, such as the Dow Jones Industrial Average or the Nasdaq Composite.

For example, if a hedge fund generates a return of +8%, its absolute return is simply +8%. However, if the S&P 500 gained +10% during the same period, its relative return would be -2% (since it underperformed the market benchmark).

Why “Absolute Return” Matters to Investors

Investors who focus on absolute return strategies prioritize consistent gains rather than outperforming a benchmark. This approach is particularly useful in uncertain or volatile markets, where traditional investing strategies may struggle.

Key reasons why absolute return strategies matter:

• Market Independence: Investors can profit in any market condition—bull, bear, or stagnant.
• Risk Management: Absolute return funds often use hedging techniques to minimize downside risk.
• Diversification Benefits: These strategies can complement traditional stock and bond investments in a portfolio.
• Consistent Performance Goals: Absolute return investors focus on achieving positive returns rather than outperforming competitors.

How “Absolute Return” Is Calculated

The formula for calculating absolute return is straightforward:

Absolute Return (%) = [(Ending Value – Beginning Value) / Beginning Value] × 100

For example, if you invest $10,000 in a fund and it grows to $11,200 after one year, your absolute return is:

((11,200 – 10,000) / 10,000) × 100 = 12%

This means your investment achieved an absolute return of +12%, regardless of how the broader market performed.

Types of “Absolute Return” Investment Strategies

Investors and fund managers use various strategies to achieve absolute returns. Some of the most common include:

• Long/Short Equity: Buying stocks expected to rise (long positions) while short-selling stocks expected to decline.
• Market-Neutral Strategies: Balancing long and short positions to reduce exposure to overall market movements.
• Global Macro Investing: Making investment decisions based on macroeconomic trends, such as interest rates, inflation, and currency movements.
• Arbitrage Strategies: Exploiting price differences in different markets or securities to generate risk-free returns.
• Hedge Funds: Many hedge funds employ absolute return strategies, aiming for positive returns in all market conditions.

Examples of “Absolute Return” in Action

To illustrate how absolute return works in different scenarios, consider the following examples:

• Hedge Fund Success: A hedge fund manager uses a combination of long and short positions to generate a 15% return in a year when the stock market declined by 5%. The absolute return is +15%, independent of market conditions.
• Real Estate Investment: An investor purchases a rental property for $500,000 and sells it five years later for $700,000. The absolute return on the investment is 40% [(700,000 – 500,000) / 500,000].
• Commodities Trading: A trader buys gold at $1,800 per ounce and sells at $2,100 per ounce, achieving an absolute return of 16.67%.

Advantages and Disadvantages of “Absolute Return” Investing

While absolute return strategies offer numerous benefits, they also have some potential downsides. Here’s a balanced view:

Advantages:

• Lower Market Risk: Investors can achieve positive returns regardless of economic conditions.
• Consistent Performance Goals: Focuses on capital preservation and steady growth.
• Diversification Benefits: Can reduce correlation with traditional stock and bond markets.

Disadvantages:

• Complex Strategies: Many absolute return strategies require sophisticated risk management techniques.
• Higher Fees: Hedge funds and absolute return mutual funds often charge higher management fees.
• Limited Upside: Some absolute return funds prioritize stability over high returns, which may underperform in bull markets.

Who Should Consider “Absolute Return” Investments?

Absolute return strategies are well-suited for certain types of investors, including:

• Risk-Averse Investors: Those looking for steady returns with reduced exposure to market downturns.
• High-Net-Worth Individuals: Investors who use hedge funds or alternative investments as part of a broader strategy.
• Retirees: Individuals seeking consistent income and capital preservation.
• Institutional Investors: Pension funds, endowments, and foundations looking for non-correlated investment opportunities.

Is “Absolute Return” Right for Your Portfolio?

Investing with an absolute return mindset can be a powerful way to achieve consistent gains, especially in volatile or uncertain markets. While these strategies require careful planning and sometimes come with higher fees, they offer investors an alternative to traditional market-based returns.

Have you used absolute return strategies in your investments? Do you prefer absolute return or relative return investing? Let’s discuss in the comments below!