What is absolute return (quick definition)
– Absolute return measures how much an investment has gained or lost over a specified period, expressed as a percentage of the starting value. It looks only at the investment’s own change in value and does not depend on any external benchmark.
Key concepts and definitions
– Absolute return: (Ending value − Starting value) / Starting value × 100%. It reports total gain or loss over the period.
– Annualized return (compound annual growth rate, CAGR): ((Ending value / Starting value)^(1 / number of years) − 1) × 100%. It converts a multi‑year total return into an equivalent per‑year rate.
– Relative return: The difference between an investment’s return and the return of a chosen benchmark (example: S&P 500). Relative return = Investment return − Benchmark return.
– Absolute‑return strategy: An investment approach that aims to make positive returns regardless of market direction. Tactics commonly used include short selling (betting a security will fall), derivatives (futures, options), arbitrage, leverage (borrowing to amplify positions), and investing in nontraditional assets.
– Hedge fund (as commonly used): An investment vehicle, often organized as a limited partnership or LLC, that pools capital from outside investors and pursues a declared strategy. Many hedge funds follow absolute‑return-style approaches; they frequently work with accredited or sophisticated investors.
How absolute return works (practical points)
– It isolates the investment’s own performance. If a stock rises from $100 to $130, the absolute return is 30%, independent of broader market moves.
– Absolute return does not tell you how the asset performed versus peers or a market index — that’s what relative return does.
– When evaluating a fund that advertises “absolute return,” check the time horizon, whether returns are net of fees, and how cash flows are treated (important for funds that have subscriptions/redemptions during the period).
Step‑by‑step: calculating absolute and annualized return
1. Record the starting value (V0) and ending value (V1) for the period.
2. Absolute return (%) = (V1 − V0) / V0 × 100.
3. If you want a per‑year equivalent, calculate CAGR: ((V1 / V0)^(1 / years) − 1) × 100.
4. To get relative return, subtract the benchmark’s return (absolute or annualized — be consistent with which you use) from the investment’s return.
Worked numeric example
Situation: You buy an investment for $10,000 and sell it four years later for $25,000. No intermediate cash flows.
1. Absolute return
– (25,000 − 10,000) / 10,000 × 100% = 150.0%
So the investment’s total gain over four years is 150%.
2. Annualized return (CAGR)
– (25,000 / 10,000)^(1/4) − 1 = 2.5^(0.25) − 1 ≈ 1.2579 − 1 ≈ 0.2579 → 25.79% per year.
This tells you the equivalent constant yearly return that compounds to the observed total.
3. Simple relative comparison
– If a benchmark rose from $10,000 to $26,000 over the same period (absolute return 160%), the investment’s relative absolute difference = 150% − 160% = −10 percentage points. If you compare annualized returns, subtract the benchmark’s CAGR from the investment’s CAGR (again, be consistent).
History and common usage
– The idea of funds explicitly trying to make positive returns in most market environments predates the modern name “hedge fund.” Alfred Winslow Jones is commonly credited with creating the first such private investment vehicle in 1949. Over time the term “absolute return fund” became associated with pooled strategies that use the techniques listed above.
Evaluating absolute‑return funds — short checklist
– Time period: Is the return reported over the same period you care about?
– Net vs. gross: Are reported returns net of management fees, performance fees, and trading costs?
– Cash flows: Are returns calculated assuming no intermediate contributions/withdrawals, or using money‑weighted returns (IRR)? Which method is used?
– Benchmarking: If the manager claims “outperformance,” ask what benchmark or hurdle they are comparing to.
– Risk and drawdown: What maximum drawdowns and volatility accompanied the returns? Absolute gains can hide large interim losses.
– Strategy transparency: Are the instruments and risk controls disclosed (use of leverage, derivatives, short positions)?
– Liquidity and investor type: Is the vehicle open to retail investors or only accredited/sophisticated investors? What are lock‑ups and redemption terms?
– Compliance and structure: Is the fund a registered product or a private partnership? How is governance and oversight handled?
Notes and assumptions
– Simple absolute return calculations assume no interim cash flows and that the reported starting and ending values are comparable (same currency, adjusted for distributions if applicable).
– For funds that pay dividends, distributions should be reinvested or added to ending value to measure true total return.
– Fees and taxes materially affect the investor’s realized return; confirm whether reported numbers are pre‑ or post‑fees and whether they account for taxes.
Reputable sources for further reading
– Investopedia — Absolute Return: https://www.investopedia.com/terms/a/absolutereturn.asp
– Vanguard — ETF profiles and return definitions (example ETF data and return calculations): https://investor.vanguard.com/etf/profile/VOO
– U.S. Investor.gov (SEC office of investor education) — Hedge funds (investor information): https://www.investor.gov/introduction-investing/investing-basics/investment-products/hedge-funds
– CFA Institute — resources on alternative strategies and performance measures: https://www.cfainstitute.org
Educational disclaimer
This explainer is for educational purposes only. It does not constitute investment advice, recommendations, or predictions. Before making investment decisions, consult qualified professionals and review official fund documentation.