Absolute Return Index - Explained
What is an Absolute Return Index?
Written by Jason Gordon
Updated at July 28th, 2021
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Table of Contents
What is an Absolute Return Index?How does an Absolute Return Index Work? Additional Metrics to Absolute Return IndexAcademic Research on Absolute Return IndexWhat is an Absolute Return Index?
An absolute return index refers to an indicator (index) in the stock market that is designed to measure absolute returns on investments. It is a statistical measure of absolute returns accrued by investments over a period of time. This index is a composite index that comprises of five indexes. The absolute return index was basically designed for hedge funds, it is for the purpose of comparing the performance of hedge funds as they individually operate in the stock market. This means that an individual hedge fund is compared with other hedge funds in the market in terms of performance.
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How does an Absolute Return Index Work?
Hedge funds are funds pooled from accredited investors and invested in various assets in the market. Usually, hedge fund managers devised strategies that help them generate earnings and returns for investors. The profits earned by a hedge fund of the losses incurred over a period of time in the stock market is the absolute return. The absolute return index on the other hand, compares the performance of one hedge fund to its peers in the stock market. The performance is measured in terms of profit and losses that can be attributed to the hedge funds. With the absolute return index, the successes and failures of investments of a particular hedge fund when compared to other hedge funds in the stock market.
Additional Metrics to Absolute Return Index
Absolute return index serve as the benchmark for the performance of many hedge funds, there are however other metrics used by hedge funds in relation to how they perform in the stock market. For instance, some hedge funds rely on certain performance standards while some have specific goals and targets they want to achieve. A hedge fund manager can set a return rate he is expecting from an investment based on the type of investment. A hedge fund that invests in real estate or bonds will not expect the same rate of return like a hedge fund invested a foreign investment. Other metrics that are important when measuring the performance of the fund include the capital available for investment, nature of investments and risks entailed, among others.
Academic Research on Absolute Return Index
- Why do markets move together? An investigation of USJapan stock return comovements, Karolyi, G. A., & Stulz, R. M. (1996). The Journal of Finance, 51(3), 951-986. This paper examines the fundamental factors that impact cross-country stock return correlations. It develops overnight and intraday returns for a portfolio of Japanese stocks using their NYSE-traded American Depository Receipts and a matched-sample portfolio of US stocks using transactions data from 1988 to 1992.
- The performance of hedge funds: Risk, return, and incentives, Ackermann, C., McEnally, R., & Ravenscraft, D. (1999). The journal of Finance, 54(3), 833-874. This study uses a large sample of hedge data from 1988-1995 to examine whether hedge funds continuously outperform mutual funds and not standard market indices. It also explores the effect of six data-conditioning biases. The results indicate that positive and negative survival-related biases offset each other.
- [PDF] Return differences between family and non-family firms: Absolute and Index differences, Mukherjee, S., & Padgett, C. (2006). Reading: University of Reading School of Business. ICMA Centre Discussion Papers in Finance DP2006-11. This paper determines whether family firms can provide a return premium when compared to their non-family counterparts. It assumes that various benefits and cost associated with family ownership can be absorbed into the business model. This hypothesis is tested using a sample of 152 family firms and matching them with non-family firms based on their sector, stock market index and size.
- Mean-absolute deviation portfolio optimization model and its applications to Tokyo stock market, Konno, H., & Yamazaki, H. (1991). Management science, 37(5), 519-531. This paper attempts to show that a portfolio optimization model using the L risk function can eliminate the majority of the difficulties related to classical Markowitz's model while maintaining its benefits over equilibrium models. Numerical experiments show that this model generates a similar portfolio to Markowitz's model in less time than that required to solve the latter.
- Modelling the absolute returns of different stock indices: exploring the forecastability of an alternative measure of risk, Granger, C. W., & Sin, C. Y. (2000). Journal of Forecasting, 19(4), 277-298. This article treats the observed absolute return as a measure of risk and examines its forecastability. It considers two simple models, a new AR-like model that is applied to the absolute return and the ARCH-like model known as the Asymmetric Power ARCH. These two models are applied to three stock indices.