Absolute Return

Absolute return, also known as total return, measures the gain or loss of an investment without comparing it to a benchmark or standard. It reflects the actual profit or loss an asset or portfolio has generated over a specific period. By focusing solely on the investment's performance, absolute return provides a clear picture of its effectiveness, independent of market or sector movements.

When you invest in mutual funds, you are often keen to know how your investment is performing. One way to gauge this is by understanding absolute returns. Absolute return is a straightforward metric that indicates the actual profit or loss generated by your mutual fund investment over a specific period.

What is Absolute Return in Mutual Funds?

Absolute return, in the context of mutual funds, represents the total gain or loss on your investment without considering the time factor. It is expressed as a percentage and gives you a direct insight into your investment's performance.

How does Absolute Return work?

1. Calculating Absolute Return

To calculate the absolute return of an investment, you need to subtract the initial investment amount from the final value (including any interest, dividends, or capital gains) and then divide it by the initial investment. The result is expressed as a percentage.

2. Independence from Benchmark

Unlike relative returns, which compare an investment's performance to a benchmark index, absolute return evaluates the investment's performance solely based on the actual gains or losses. It doesn't consider whether the market as a whole is up or down.

3. Risk ManagementWhy
absolute return matters

Absolute return is often used by investors and fund managers to assess the success of an investment strategy or a fund. It allows them to focus on the specific performance of an asset or portfolio rather than being influenced by market conditions.

4. Asset Allocation

It can be a valuable tool for asset allocation in a diversified portfolio. By considering the absolute return of individual assets, investors can make informed decisions about how to balance their investments for the best overall performance.

Absolute Return Formula and Example

Calculating absolute return is quite simple. Let's say you invested Rs. 50,000 in a mutual fund on January 1, and its current value on December 31 is Rs. 60,000. To find the absolute return:

Absolute Return = [(60,000 - 50,000) / 50,000] * 100 = 20%

So, your absolute return for the year is 20%.

Why absolute return matters

Absolute return is an essential metric for investors, especially when evaluating the performance of mutual funds. It provides a clear, straightforward calculation of the total return earned by an investment over a specific period, without comparing it to any benchmarks or market indices. By focusing on the actual gain or loss, absolute return in mutual funds helps investors understand the fund’s performance in isolation.

This metric is particularly useful for short-term investors who want to know how much their money has grown, regardless of market conditions. For example, if a mutual fund grows from Rs. 1,00,000 to Rs. 1,20,000, the absolute return would be 20%, offering a clear picture of the fund's success over that period.

Absolute return is a key measure for investors who prioritize tangible growth in their portfolios and need a direct view of their investment's profitability. It also helps in decision-making, especially when comparing different investment options.

Importance of Absolute Returns

Absolute returns hold significant importance in investment evaluations due to several reasons:

1. Enhanced portfolio diversification: Absolute returns contribute to building a diversified investment portfolio aimed at achieving better overall returns. By focusing on absolute returns, investors can diversify their investments across various asset classes and securities, reducing the overall risk exposure of their portfolio.
2. Short-term and Long-term potential: Absolute returns cater to investors with different time horizons, offering the potential for both short-term and long-term gains. While some investors seek faster returns in the short term, others opt for a longer investment horizon to maximize their overall returns.
3. Resilience to market volatility: Absolute returns are less susceptible to the fluctuations and volatility of financial markets compared to relative returns. This resilience allows investors to maintain a more stable investment strategy and mitigate the impact of market uncertainties on their investment portfolios.
4. Dynamic risk management: Absolute returns facilitate dynamic risk management strategies, enabling investors to adjust their investment allocations based on changing market conditions and risk profiles. This flexibility empowers investors to make informed decisions to safeguard their investment capital while pursuing attractive returns.
5. Focus on positive returns: The primary objective of absolute returns is to generate positive investment returns irrespective of market conditions. This goal-oriented approach aligns with investors' expectations of achieving growth and preserving the value of their investment capital over time.
6. Simplicity in calculation: Absolute returns offer a straightforward and easy-to-understand method of calculating investment performance. By comparing the initial investment with the final value, investors can quickly assess the absolute return generated by their investment, making it a simple and accessible metric for investment analysis.

When to use Absolute Return analysis?

Absolute return analysis can provide valuable insights in various investment scenarios. Here are situations where it is most useful:

1. Comparing investments: Absolute return is ideal for comparing different investments as it excludes the impact of market fluctuations, giving a clearer view of each investment’s individual performance.
2. Evaluating long-term investments: It helps assess long-term investments like retirement funds or education savings plans by showing whether the investment is on track to meet specific financial goals.
3. Assessing fund performance: Absolute return can be used to evaluate the performance of mutual funds, hedge funds, and other managed portfolios without the need to benchmark against market indices.
4. Measuring risk-adjusted Returns: Since absolute return accounts for the risk associated with an investment, it offers a better understanding of performance, especially when comparing investments with similar returns but varying risk levels.
5. Customising investment strategies: Investors can tailor their strategies to align with their risk tolerance and financial goals using absolute return, without relying on a market index or benchmark for comparison.

Difference Between Absolute Return and Relative Return in Mutual Funds

Absolute return provides the actual gain or loss on your investment, while relative return compares your fund's performance to a benchmark index (Like Nifty). While absolute return is an exact measure, relative return gives you an idea of how well your fund performed compared to its peers or the market. Here is a table comparing Absolute Return and Relative Return in mutual funds: