Absolute returns can be positive or negative. It is also referred to as the “total return” on investment and is measured by gains or losses using percentages.
It takes on a different approach because it does not compare returns to any external standard or other market activities. Absolute returns are only concerned about the return a particular asset achieves over a specified time frame.
Where the relative return is compared to external benchmarks over a specific amount of time, absolute return is not and is simply what the asset returned over that specified period.
Example of Absolute Returns
A mutual fund that had a starting net asset value (NAV) of $100 and an ending NAV of $110 after one year.
In this case, the absolute return for the mutual fund over that year would be 10%, which is calculated as:
(Ending NAV – Starting NAV) / Starting NAV * 100% =
($110 – $100) / $100 * 100% = 10%
This means that the value of the mutual fund increased by 10% over the course of the year, without any reference to how it performed compared to a benchmark or market index.
Why Absolute Returns are Important
1. Investment performance: The absolute return provides a simple way to understand the overall performance of the investment, and can be useful in evaluating the performance of the fund over time.
2. More focus on investment wins: Fund managers who focus on absolute returns work towards diversifying asset classes so that returns can be earned regardless of market swings or dramatic events. They usually aim for short-term investment wins.
3. Consistent returns: Absolute returns can be especially useful for investors who are primarily concerned with preserving their capital or generating consistent returns, rather than outperforming a benchmark or market index.
For example, investors who are saving for a specific goal, such as a down payment on a home or a child’s education, may be more interested in the absolute returns of an investment than in its relative returns.
4. Fund evaluation: Absolute returns can be helpful for evaluating the performance of actively managed investment products, such as mutual funds or hedge funds. By looking at the absolute returns of these products over time, investors can see how effective the fund managers have been at generating positive returns for their clients.
Summary
Absolute returns are calculated as the return an asset or portfolio makes over a specified time frame. Unlike relative returns, it is not compared to external factors or market swings.
They are an important tool for investors to use when evaluating the performance of their investments and can provide a meaningful measure of how an investment is doing.
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