In the market, there is a great variety of vehicles and financial instruments that you can use to put your capital “to work”. What do we mean? Basically because any of them will give you the opportunity to multiply your savings or your income and thus make the most of your money. What instruments are we talking about? From savings accounts, fixed-income securities, investment funds, retirement planscertificates of deposit and the like.
However, choosing the right one to channel your investments could be tricky. For example, mutual funds do not always offer the same thing. Some are relative return and others are absolute return.and within those of absolute return, you will also find several types: fixed income, foreign exchange, etc.
That is why we decided to make a special section for you who are looking to invest. Soon you will discover everything you need to know about absolute return.
What is absolute return?
The absolute return is nothing more than the total return that is obtained from an asset in a specific period of time. Through this factor, investors and investment fund managers determine the appreciation or depreciation of the invested capital.
This value is expressed, as in many other investment instruments, as a percentage. Through this percentage, administrators and banks promote their shares, mutual funds, among others; thus telling their clients how much they could earn in a period of six months, a year or more.
Absolute return differs from relative return because it only focuses on calculating the performance of a particular asset. What this means is that it does not compare it to a national or international benchmark, such as the S&P 500 Index, for example.
To sum up: The absolute return is the return generated by an asset – stock, investment, bond – in a given period. This return can be positive (appreciation) or negative (depreciation). Due to their own characteristics, it could be said that absolute return investment funds try to separate themselves from the state of the market. Later we will see why.
How does absolute return work?
As we said, the absolute return focuses on calculating the amount of money that the fund manager and its investors have earned with an investment. This type of return is also known as total return. because it measures the actual gain or loss on an investment asset or portfolio, regardless of the most famous market benchmarks. This is what allows them to show positive or negative performance.
Differences between absolute return and relative return
The best way to understand how absolute return works and how it differs from relative return is to compare them, and in this case, we’ll do it in light of mutual funds. The relative return mutual funds have one goal: to outperform everyone else, including your competition.
Therefore, they promote the mutual fund as the perfect means to obtain a return higher than a certain reference index, such as the S&P 500, for example. Why is return said to be relative? Because your success will depend on whether or not you manage to beat the return on investment of the index.
Now, it is important that you take into account that, if the fund exceeds the investment index, this does not mean that you have made money, at least not necessarily. Think about it, if the fund outperforms the S&P500 Index by five points but the S&P500 Index, in turn, fell ten points over the same time period; then your return would not be 5%.
And this is where you will see the difference between this type of investment fund and absolute return mutual funds. In this case, the fund manager will do whatever it takes to earn a positive return, regardless of the marketthat is, the performance of the most popular indices in the country.
To achieve this, he invests in the foreign exchange market, leverages himself, goes short and trusts unconventional assets and minimal risk. The return obtained -for example, 10%- will be absolute, since it is not compared or linked to any index or reference point.
What is the origin of these funds?
The creator of the first absolute return mutual fund was Alfred Winslow. Even if its launch dates back to 1949 in New Yorkthe truth is that it quickly spread as an investment mechanism worldwide.
In recent years, absolute return mutual funds have become a popular alternative, especially after the implementation of hedge funds.
What is a hedge fund?
These types of funds generally specializes in a specific area, such as real estate, patents, and some private equity activities. While anyone could invest in a hedge fund, most participants are long-time, accredited investors.
Absolute Return Example
Let’s look at a real life case, so to speak. The Vanguard 500 Index Fund Investor Shares ETF (VFINX) reported a 150.15% absolute total return over a 10-year period. This return differed from his annualized return, which had been 8.37% per year for the same period.
Compared to the absolute return of the S&P 500 – which was 153.07% over the same ten-year period – then their relative return would have been negative (-2.92%).