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Absolute return investing is popular among institutional investors in financial products such as pension funds and endowments. The goal of absolute return investing is to generate positive returns in all market conditions, regardless of whether the overall market is going up or down.
What is absolute return?
The return on an investment during a given period is the absolute return. It represents the overall increase or decrease in the asset’s value as a percentage. It evaluates the overall loss or profit from the investment and can be either positive or negative. The strategies utilised in absolute return investing is likewise aimed at achieving short-term gains because they are short-term oriented.
To calculate the absolute return, you subtract the initial investment amount from the final investment amount. This will give you the total return for the investment over the specified period.
Understanding absolute return
An absolute return is an actual return on investment without considering the effect of inflation or other economic factors. In other words, it is the “real” return on investment. For example, if you invest in a stock that goes up by 10% but inflation is 3%, then your absolute return is 7%.
There are several different absolute return strategies that investors can pursue. Some common approaches include long/short equity, global macro, managed futures, and hedge funds. Each of these strategies has its distinct risks and rewards.
Absolute return analysis may be used to choose the mutual fund for investors ready to take on risk in exchange for both short- and long-term profits. If investors choose the correct funds for a long-term perspective, they can expect high returns.
Overall, absolute return investing can greatly diversify your portfolio and generate consistent returns in all market conditions. However, it is important to understand the risks involved before investing.
How does absolute return work?
Absolute Return operates by putting methods in place to provide profitable results. However, as this return metric lacks a comparative benchmark to compare it to, it employs strategies including arbitrage, short selling, options, futures, leverage, derivatives, and unusual assets.
Only losses or profits on the investment are considered absolute return and are analysed apart from any additional performance indicator.
Additionally, it can only be quantified in terms of the percentage return produced, which creates biases in favor of funds with a large asset base over funds with a small asset base.
Absolute return is calculated using the initial investment amount and the investment’s current value. The difference between an investment’s current worth and its initial value is known as the investment’s initial value.
This return is typically calculated over terms of less than a year. All that is needed in the case of mutual fund investments are the initial value NAV and the ending value NAV (present NAV). When calculating these returns, the asset length within the fund is unimportant.
Benefits of absolute return
It offers returns earned in actual terms and is unaffected by comparing benchmarks and periods.
As it ignores intermittent changes, it aids in lowering overall volatility.
Absolute return funds may reduce a particular risk, such as changes in interest rates or market volatility. They have more freedom than traditional investments to develop portfolio positions and hedging strategies using several techniques, including derivatives.
Absolute return funds guarantee a profit despite market volatility.
They can adopt strategies not in line with the trend of the bond or stock markets since they are independent of traditional benchmarks.
For all users, it is simple to calculate and understand.
Example of absolute returns
For example, let’s use Mr. X as an investor who contributed 350 USD to a mutual fund. The investment is currently worth 450 USD. The formula above may be used to estimate Ms. Vani Kumar’s absolute return:
(450 USD –350 USD)
Absolute return is equal to —————————————— X 100
The total return is 28.57%.
Mr. X received a return on her mutual fund investment of 28.57%. However, this return does not account for how long the investment was made. Mr. X would have received this payment in five or fifteen years. This is not apparent from point-to-point returns. Thus, mutual funds typically calculate annual returns for any period longer than a year.
Frequently Asked Questions
Calculating absolute return is straightforward. Only two values are required to evaluate this return on investment. They are the initial investment as well as the investment’s current worth. The formula to calculate the absolute return is given below:
Current value of investment – initial investment
Absolute return = ——————————————————————— X 100
Absolute return is the total amount a portfolio or asset earned over a specific time frame. The difference between absolute return and the market’s performance, measured by a benchmark or index like the S&P 500, is known as the relative return.
Regarding mutual funds, absolute return (also known as point-to-point returns) refers to the entire returns from a mutual fund. As such, it is the mutual fund return calculated independently of any benchmark index. Fund managers refer to the absolute return when discussing optimising a mutual fund’s return.
There are a few key differences between absolute return and compound annual growth rate (CAGR).
Absolute return is a measure of the actual return achieved over a specified period, while CAGR measures the return achieved if the investment had grown at a constant rate over the same period.
A absolute return includes both the positive and negative returns achieved, while CAGR only consists of the positive returns.
CAGR is typically used to measure the performance of an investment over a longer period, while absolute return is more appropriate for measuring performance over a shorter period.
Unlike absolute return, which measures the point-to-point return out of an investment without taking into account the time required to acquire it, CAGR accurately depicts the year-on-year return generated by an investment. Thus, CAGR is a widely used metric.
Ultimately, it is up to the individual investor to decide which measure is more important to them.
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