What is Absolute Return in Mutual Funds?

Absolute return has gained a lot of attention in mutual fund investing throughout the years. Unlike traditional funds that strive to out perform a particular benchmark index, these mutual funds focus on generating positive returns regardless of whether the market is rising or going down. This approach allows investors to have a somewhat stable investment portfolio. 

In this article, we will share what absolute return exactly is, and how it works. 

What Is Absolute Return?

Absolute return mutual funds make money for the investors regardless of what happens in the stock market. In simple words, the best absolute return mutual funds focus on making good profits over a fixed period of time, regardless of whether the market is rising or going down. 

One main factor that differentiates absolute return in mutual funds is their ability to use different investment methods and different types of assets. These mutual funds can invest in stocks, bonds, and financial contracts and deliver consistent positive returns, even during volatile market phases. 

However, it is absolutely important for investors to carefully assess their track record and risk management before considering investing into absolute return mutual funds. 

The History of Absolute Return Funds

Absolute return funds have their history back to the latter half of the 20th century. They were introduced as a response to the demand for investment methods that would produce profitable returns, regardless of the state of the market. Thus, investors could have a potential substitute for the traditional mutual funds. 

Importance of Absolute Return

Absolute returns are important to build a diversified investment portfolio because they can help you achieve better returns and reduce risk exposure. One can expect good returns over a specific period of time by investing in absolute return mutual funds. Moreover, these funds do not work like traditional mutual funds — which make them a good choice for your portfolio. 

How Absolute Return Works

Absolute return in mutual funds use various techniques and strategies to generate positive returns. Here is a simple explanation of how absolute return works:

Long and Short Positions: Absolute return funds can take long buying and short selling positions and thus, creating a profit by lowering prices of certain securities and market segments with short positions. 

Active Management: Fund managers of absolute return mutual funds actively monitor and make changes in their investment portfolios to capitalize on potential opportunities in the market. To maximize their mutual fund returns, they may use investment strategies such as market timing, sector rotation, and tactical asset allocation. 

Risk Management: These funds also use risk management strategies such as diversification hedging and stop-loss orders. Such practices help limit any potential losses and preserve capital. 

Focus on Absolute Performance: Unlike traditional funds, absolutely return funds focus on generating positive returns regardless of how the overall market performs. 

Lower Correlation: The best absolute return fund strategies focus on delivering less correlated returns with broader market movements. This move can help to diversify an investor's portfolio and reduce the impact of market volatility. 

Even with all these positive points, it's important to acknowledge that absolute return in mutual funds vary across mutual funds. Therefore, one should carefully review the fund's investment strategy, historical performance, and risk management strategies before considering investing. 

What is the Absolute Return Formula?

The absolute return formula can be used to calculate the absolute return on investments. Here's the absolute return formula:

Absolute Return = {(Final Value - Initial Value) / Initial Value} * 100

Let's implement this formula in an example to understand it better. Consider that you initially invest ₹10,000 and the capital grows to a final value of ₹12,000. So, the absolute return would be { (₹12,000 - ₹10,000) / ₹10,000} * 100 = 20%. Thus, the absolute return on your investment would be 20%.

Difference between Absolute & Relative Return in Mutual Funds

Difference between absolute return and relative return lies in the benchmark index. The absolute return is the return that a mutual fund provides over a specific period of time. These returns aren't compared to any benchmark index.

However, relative returns are the returns that are compared to a benchmark index in the country. It is basically the difference between the absolute return and the market index return. The relative return in mutual funds aim to produce such results that beats the benchmark. 

Difference between Absolute Return and Annualized Return

The main difference between absolute return and annualized return life in the time frame calculation method used in the two. Absolute return mutual funds represent the total return on an investment as a percentage. Thus, indicating the overall profit or loss generated during that specific time period. 

On the other hand, annualized return represents the average return rate per year over a specific period of investment timeframe. The fund considers the compounding effect as it assumes the investment's return compounds per annum. Therefore, investors can compare the performance of their investments with different investment periods on an equal basis and evaluate their overall average growth rate. We can say that the annualized return provides a standard metric to assess long-term performance of one's investments. 

Difference between Total Return and Absolute Return

Absolute return in mutual funds focuses on generating positive returns regardless of the condition of the overall market. These funds often use an absolute benchmark to describe their investment goal — which is to offer stable returns over a specific period of time. 

On the other hand, total return considers both the impact of dividends and absolute return. These funds use a market benchmark to compare their performance. The total return index (TRI) is a benchmark that measures both capital appreciation and dividend returns in the market. This index assumes that all the dividends are reinvested. 

FAQs

1. What is absolute return with an example?

Absolute return is the percentage of how much gain or loss an investment has generated over a specific period of time. For example, if you invested ₹5,000 initially and today, the value of your investment is ₹6,000, you made a total gain of ₹1,000 which is equal to an absolute return of 20%.

2. What is the absolute value of returns?

Absolute return is the absolute gain or loss that an investment has generated over a specific period of time, expressed as a percentage. 

3. What is an absolute return strategy?

An absolute return strategy is a type of investment strategy that focuses on generating positive returns, regardless of the market situation. These strategies often differ from traditional mutual funds and include short selling, derivatives, and leverage. 

4. Is absolute return good or bad?

Absolute returns don't compare their returns to any benchmark or index, and thus, can be positive or negative. These only focus on the initial investment and the final amount to finalise the gain or loss absolute return.