Absolute Return Funds
Absolute return funds strive to achieve a positive return on investment (ROI) over a specified period, independent of overall market performance. These funds employ various strategies and instruments to reach their goals, making them different from traditional funds that typically aim to outperform a benchmark index.
Key Characteristics of Absolute Return Funds:
1. Objective: To generate consistent positive returns, regardless of market conditions.
2. Strategies: Utilizes a mix of investment strategies, such as long/short positions, derivatives, arbitrage, and alternative investments.
3. Risk Management: Focus on capital preservation and risk minimization, often employing hedging techniques.
4. Flexibility: Can invest in a wide range of asset classes, including equities, bonds, currencies, commodities, and real estate.
5. Performance Measurement: Returns are measured in absolute terms, rather than relative to a benchmark index.
How Do They Work?
Absolute return funds often use advanced investment techniques:
- Long/Short Positions: Buying securities expected to increase in value (long) and selling securities expected to decrease in value (short).
- Derivatives: Using options, futures, and other derivatives to hedge risk or leverage positions.
- Arbitrage: Exploiting price differences between related securities.
- Diversification: Investing in a broad array of assets to spread risk.
Benefits of Absolute Return Funds:
1. Potential for Positive Returns: Aims to deliver positive returns in various market conditions.
2. Risk Mitigation: Focuses on preserving capital and managing risk through diverse strategies.
3. Flexibility: Can adapt to changing market conditions and opportunities.
Considerations of Absolute Return:
- Complexity: Strategies can be complex and require skilled management.
- Fees: Often have higher fees due to active management and sophisticated strategies.
- Performance Variability: While aiming for positive returns, there is no guarantee of success, and performance can vary.
Who Should Consider Absolute Return Funds?
- Risk-Averse Investors: Those looking to minimize losses during market downturns.
- Diversification Seekers: Investors wanting to diversify their portfolios with non-traditional strategies.
- Long-Term Investors: Those who are patient and can afford to wait for the fund's strategies to play out.
Absolute return funds can be a valuable addition to an investment portfolio, offering the potential for steady returns and risk management through various market conditions. However, due diligence is crucial to understand the fund’s strategies, risks, and management approach.
Difference Between Annualised Return and Absolute Return
Absolute Return:
- Definition: The total return on an investment over a specified period, without considering the length of time.
- Calculation: It measures the percentage increase or decrease in the investment's value from the initial investment.
- Formula: \[ \text{Absolute Return} = \left( \frac{\text{Ending Value} - \text{Initial Value}}{\text{Initial Value}} \right) \times 100 \]
- Example: If you invest $1,000 and it grows to $1,200 over 3 years, the absolute return is \( \left( \frac{1,200 - 1,000}{1,000} \right) \times 100 = 20\% \).
Annualised Return:
- Definition: The geometric average amount of money earned by an investment each year over a given time period.
- Calculation: It adjusts the absolute return for the length of time the investment is held, giving an annual return rate.
- Formula: \[ \text{Annualised Return} = \left( \left( \frac{\text{Ending Value}}{\text{Initial Value}} \right)^{\frac{1}{n}} - 1 \right) \times 100 \]
where \( n \) is the number of years.
- Example: Using the same investment, $1,000 growing to $1,200 over 3 years:
\[ \text{Annualised Return} = \left( \left( \frac{1,200}{1,000} \right)^{\frac{1}{3}} - 1 \right) \times 100 \approx 6.27\% \]
How to Calculate Both
Absolute Return Calculation:
1. Identify Initial and Ending Values: Determine the initial value (IV) and the ending value (EV) of the investment.
2. Apply the Formula:
\[ \text{Absolute Return} = \left( \frac{\text{EV} - \text{IV}}{\text{IV}} \right) \times 100 \]
Example Calculation:
- Initial Investment (IV): $1,000
- Ending Value (EV): $1,200
\[ \text{Absolute Return} = \left( \frac{1,200 - 1,000}{1,000} \right) \times 100 = 20\% \]
Annualised Return Calculation:
1. Identify Initial and Ending Values and Time Period: Determine the initial value (IV), ending value (EV), and the number of years (n).
2. Apply the Formula:
\[ \text{Annualised Return} = \left( \left( \frac{\text{EV}}{\text{IV}} \right)^{\frac{1}{n}} - 1 \right) \times 100 \]
Example Calculation:
- Initial Investment (IV): $1,000
- Ending Value (EV): $1,200
- Time Period (n): 3 years
\[ \text{Annualised Return} = \left( \left( \frac{1,200}{1,000} \right)^{\frac{1}{3}} - 1 \right) \times 100 \approx 6.27\% \]
Summary:
- Absolute Return provides the total percentage return over the entire investment period.
- Annualised Return provides the average yearly return, making it easier to compare the performance of investments held for different time periods.
Both measures are useful, with absolute return giving a snapshot of total growth and annualised return standardising the return for annual comparison.