What it means
Most funds are judged relative to a benchmark. A fund that loses 5% in a year when its index lost 12% has "outperformed" by 7 points, and its manager may be paid a bonus for it, even though every investor in the fund lost money.
Absolute return cuts through that framing by asking the only question a saver ultimately cares about: did the money grow? The measure is simply the return itself, and the philosophy is that a manager's job is to make money, not to lose less than an index.
Absolute return strategies, which became widespread through hedge funds and later in retail funds, try to deliver that promise. They typically hold long positions in assets expected to rise and short positions in assets expected to fall, use derivatives to hedge market exposure, allocate across asset classes and geographies, and target a return such as "cash plus 4% a year" with lower volatility than equities.
The approach can reduce the impact of market falls, but it does not remove risk: absolute return funds have lost money in difficult periods, and the fees for the extra complexity are usually higher. The measure itself has limitations.
An absolute return of 6% is excellent when cash yields 1% and markets fell, and poor when cash yields 5% and markets rose 25%. The number needs context: what was the risk taken, what did alternatives return, and over what period.
Investors therefore read absolute return alongside relative return, risk-adjusted measures such as the Sharpe ratio, and the maximum drawdown the strategy suffered. Time also matters: absolute returns should be annualised for comparison across periods of different lengths, and a single strong year says little about a strategy.
For individuals, absolute return is the natural way to think about a pension or savings goal, which is defined in money terms, not in points over an index. For institutions, it is one lens among several.
In practice
Real-world examples.
Example
A retiree's portfolio returns 4% in a year when the stock market falls 15%; the absolute return is positive and the retiree's income is protected.
Example
A hedge fund targets an absolute return of cash plus 5% and reports 9% for the year with the market up 20%, which its investors accept because the fund's mandate was never to match the market.
Example
A pension scheme's absolute return over ten years is 6.2% a year, which it compares with the 5% it needs to meet its liabilities rather than with any index.
Think of it
“Absolute return is what you actually make-positive or negative-without comparing to any benchmark.
Formula
Calculation
Absolute Return = (Ending Value minus Beginning Value + Income received) / Beginning Value x 100%
Annualised Absolute Return = ((Ending Value / Beginning Value) to the power (1 / years)) minus 1
Relative Return = Absolute Return minus Benchmark Return
Worked example. An investor puts $200,000 into a fund. Three years later the holding is worth $236,000, and the fund paid out $9,000 of distributions over the period that the investor took as cash.
- Absolute return = ($236,000 minus $200,000 + $9,000) / $200,000 = $45,000 / $200,000 = 22.5%
- Annualised, ignoring the timing of distributions for simplicity: (($236,000 + $9,000) / $200,000) to the power (1/3) minus 1 = 1.225 to the power 0.333 minus 1 = 7.0% a year
Over the same three years the equity index the fund is often compared with rose 30% (9.1% a year) and cash returned 6% (2.0% a year).
- Relative return against equities = 22.5% minus 30% = minus 7.5 points
- Relative return against cash = 22.5% minus 6% = plus 16.5 points
An absolute return investor sees a fund that grew their money 7% a year with, say, half the volatility of equities, and judges it a success. A relative investor sees a fund that lagged the market. Both are reading the same number.
Drawdown check: during the three years the fund's worst peak-to-trough fall was 6%, against 22% for the equity index. The lower absolute return came with substantially lower risk of loss.Case study
Seen in the real world.
A charity's investment committee had judged its fund manager against a global equity index for a decade. In a year when the index fell 28% and the fund fell 24%, the manager reported outperformance of 4 points and the committee, following its policy, approved the performance fee. A new trustee, a retired finance director, asked how paying a fee for losing a quarter of the endowment served the charity's beneficiaries, whose grants depended on the fund's absolute value.
The committee revised its framework: the manager's objective became an absolute return of inflation plus 4% a year over rolling five-year periods, with the equity index retained as a secondary reference and performance fees payable only on absolute gains above a high-water mark. The manager adjusted the portfolio to hold more diversifying assets. In the following downturn the fund fell 9%, the charity maintained its grants, and the trustee's remark that "beneficiaries cannot eat relative performance" became the committee's shorthand for its policy.
Watch out
Common mistakes.
- Judging an absolute return without context. The same 6% can be excellent or poor depending on cash rates, inflation and the risk taken.
- Assuming absolute return funds cannot lose money. They aim for positive returns in all conditions but do not guarantee them.
- Comparing absolute returns over different periods without annualising, or over short periods that say nothing about a strategy.
Questions
People also ask.
What is the difference between absolute and relative return?
Absolute return is the gain or loss on the investment itself. Relative return is that gain or loss compared with a benchmark.
Are absolute return funds a good investment?
They suit investors who prioritise avoiding losses over capturing every market rise, and who accept higher fees for lower volatility. Their record varies widely by fund.
Should I measure my own investments on an absolute basis?
For goals defined in money terms, such as retirement or a house deposit, yes. Relative performance tells you how your manager did; absolute return tells you whether you will reach the goal.
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