What is Absolute Return
Absolute Return refers to the actual amount of money made or lost on an investment, regardless of the performance of a benchmark or market index. An absolute return strategy aims to achieve a positive return in both rising and falling markets. This contrasts with a relative return strategy aiming to outperform a benchmark or market index.
Absolute return strategies are typically used in hedge funds and other alternative investments. Unlike Relative Return, which compares the performance of an investment to a benchmark (such as a stock market index), absolute Return is measured in terms of the actual profit or loss of the investment.
How to Calculate Absolute Return
To calculate the absolute Return, you would take the change in the value of an investment over a specific period (such as a year) and express it as a percentage of the initial investment. The formula is as follows:
Absolute Return = (Closing Price - Opening Price) / Opening Price
For example, if you invested $100 in a stock and it increased in value to $120 over a year, the absolute Return would be:
Absolute Return = ($120 - $100) / $100 = 0.20 or 20%
It's important to note that absolute Return is not adjusted for inflation. To know the real Return, you can use real Return (nominal Return - Inflation).
Advantages of Absolute Return
Some advantages of absolute Return include the following:
- Flexibility: Absolute return managers have more flexibility to adapt to changing market conditions.
- Potential for positive returns: Absolute return strategies aim to provide investors with a steady income stream.
- Low correlation with traditional assets: Absolute return strategies often have a low correlation with traditional asset classes like stocks and bonds, which can help to diversify a portfolio.