Absolute Return - Explained
What is the Absolute Return on an Asset?
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Table of ContentsWhat is Absolute Return?How is the Absolute Return Determined? Relative and Absolute ReturnsHistory of Absolute Return FundHedge FundsExample of Absolute ReturnAcademic Research on Absolute Return
What is Absolute Return?
An absolute return refers to appreciation or depreciation that an asset accrues over a given period of time. It is the evaluation of the performance of an asset in relation to how much gain or loss it has made and incurred over a period of time. An absolute rate is expressed as a percentage of the capital invested in the asset. An absolute return should not be confused with a relative return, both terms are distinct terms with varying significance. While an absolute return is a measure of how well or badly an investment portfolio has performed, a relative return compares the performance of the portfolio to a market benchmark.
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How is the Absolute Return Determined?
The absolute return of asset is the profits made or losses incurred by the asset over a given period of time. An absolute return is also known as the total return, it is a measure of the gain or loss that an investment portfolio or an asset experience over a period of time. The absolute return of an asset can either be positive or negative. In some cases, market activities and trends might not affect the absolute return of an asset. The absolute return of an investment portfolio is not determined by the market benchmark, as seen in the case of a relative return.
Relative and Absolute Returns
A relative return of an asset is not the same as the absolute return, basically, absolute return measures the loss and gains accumulated by an asset or investment portfolio over a period of time without regard to the market benchmark or market trends. Relative return on the other hand, compares the performance of an asset in terms of losses and gains to the benchmark portfolio in the investment market. When an investor makes decisions by comparing the performance of an investment portfolio to its peers or other portfolios in the market, this is a relative approach to investing. Absolute return on the other hand, examines the performance of an asset or investment portfolio separate from its peers in the market.
History of Absolute Return Fund
The history of absolute return fund cannot be discussed without making reference to Alfred Winslow Jones. This is because the creation of absolute return funds is credited to him. The first absolute return fund was formed in New York in 1949 by Alfred Winslow Jones. The absolute return approach to fund investment is based on measuring the gain or loss that an asset or investment portfolio accrue over a period of time. The creation of absolute return fund birthed the common and most effective investment products that are available today, these are hedge funds.
A hedge fund is an investment instrument or product realized from pooling a significant amount of capital from various investors with the goal of investing the pooled funds in assets or investment portfolios. Typically, a hedge fund is formed as a private limited partnership or limited liability company (LLC). The funds raised in a hedge fund is operated by a hedge fund manager who specializes in investments characterised by complex portfolio-construction. However, diverse risk management strategies are employed by the hedge fund manager to earn active return or alpha from investors that are contributors to the hedge fund.
Example of Absolute Return
If a mutual fund company earns a 15% profit on the mutual fund investment for a given period of time, the absolute return of the fund is 15%. Compare this to relative return; In the case a relative return, if the return of the market benchmark is 10% and the mutual fund realizes a return of 15%, the relative return would be 5%. The absolute return gives no regard to the benchmark portfolio in the market.