What it means
In its simplest sense, absolute return answers one question: how much did this investment make or lose? If $200,000 grew to $218,000 and paid $2,000 of income along the way, the absolute return is the total gain divided by the starting amount, whatever the market did.
This differs from relative return, which compares the result with a benchmark such as a stock market index. A fund that gains 6% in a year when the market gains 10% has a positive absolute return but a negative relative return of 4 percentage points.
The same words are also used for a style of investing. Absolute return funds aim to deliver positive results across market cycles, often by combining long and short positions, derivatives (contracts whose value depends on another asset) and diversified holdings, instead of simply following the market up and down.
Such funds appeal to investors who dislike losses, such as retirees, endowments and businesses holding spare cash. They are usually judged against a cash-based target, for example the risk-free rate plus a few percentage points, and not against a share index.
That target is stated in the fund's documents, so investors can check it. The label does not guarantee a profit.
These funds can and do lose money, they usually charge higher fees than index funds, and in strong bull markets they often trail the market because they give up some upside to reduce risk. When reading performance figures, it helps to ask which meaning is intended.
A report that says a fund has an absolute return of 8% is simply stating its gain, whereas a fund described as an absolute return fund is making a promise about its aims.
In practice
Real-world examples
Example 1
A retiree holds $500,000 in a diversified fund that aims for steady positive returns. In a year when stock markets fall 8%, her fund gains 1.5%. She is satisfied because her goal was to avoid losses, not to match the market. Her adviser records the result as an absolute return of 1.5% for the year.
Example 2
A company treasurer invests $3,000,000 of surplus cash for twelve months. The board asks for the absolute return so it can compare the gain with the interest on a bank deposit. The treasurer reports a gain of $96,000, or 3.2%.
Example 3
A university endowment reviews its managers. One manager beat the market by 2 percentage points but lost 5% in absolute terms in a falling market. The investment committee notes that beating a falling market is no comfort for a body that needs to fund scholarships.
Think of it
Absolute return is what you actually make-positive or negative-without comparing to any benchmark.
Formula
Calculation
Absolute return = (Ending value - Starting value + Income received) / Starting value
Suppose an investor buys a portfolio for $200,000. A year later it is worth $218,000, and it paid $2,000 in dividends. Absolute return = (218,000 - 200,000 + 2,000) / 200,000 = 20,000 / 200,000 = 10%. If the market index returned 12% over the same year, the relative return is 10% - 12% = -2 percentage points, even though the absolute return is positive.Case study
Seen in the real world
Greystone Family Office is an illustrative, fictional investment office that manages money for three generations of one family. The senior trustee insists on judging performance by absolute return, since the family spends from the portfolio each year and cannot spend relative outperformance.
In a bad year for markets, the portfolio's growth assets fell 14%, while its absolute return holdings, which made up 30% of the portfolio, gained 2%. The overall portfolio of $50,000,000 therefore lost about 9.2%, or $4,600,000, compared with the $7,000,000 loss that a fully invested growth portfolio would have suffered.
The trustees noted that the cost was a lower return in good years, because the protective holdings gave up part of the gains when markets rose. They reviewed the 30% allocation annually and agreed to keep it, since the family valued predictable spending money above beating an index. The illustrative lesson is that an absolute return approach trades some upside for protection, and it suits investors who value stability over beating an index.
Watch out
Common mistakes
- Assuming that an absolute return fund can never lose money, when the term describes an objective and not a guarantee.
- Ignoring income, such as dividends or interest, when working out the return on an investment.
- Judging a fund only on absolute return in a rising market, when most investments make money and the question is whether it did better than alternatives.
Questions
People also ask
What is the difference between absolute and relative return?
Absolute return is the gain or loss on its own, while relative return compares that gain or loss with a benchmark.
Are absolute return funds safer than index funds?
They aim for steadier results, but they use more complex strategies and charge higher fees, so they carry their own risks.
Is absolute return the same as total return?
They are similar, as both count price change and income, but total return is often used for a specific period and may be annualised.
Watch