To know how much money they’ve made or how much money they may make, investors should review their investments regularly. Online calculators make it simple to determine one’s return on investment in this day and age. On the other hand, knowing how to calculate the return on a mutual fund might be useful. What are absolute returns and relative returns, as well as how to calculate them, are discussed here.

Absolute Returns

Absolute return means Investment returns over a defined length of time. The overall increase or decrease in the asset’s value may be calculated using a percentage as a unit. The overall gain or loss from the investment might be positive or negative, and it can be either one or the other.

Absolute return means (also known as point-to-point returns) in the context of mutual funds refer to the overall return a mutual fund has generated. Mutual fund performance that isn’t measured against any other metric is known as the “fundamental return.” To maximise a mutual fund’s total returns, the fund managers refer to the fund’s absolute return.

How do Absolute Returns work?

Based on the investment’s current market value, this return is determined. An investment’s return is defined as the difference between the current value and the original investment value. This return is often utilized for calculating returns over a period of less than a year. Investing in mutual funds only requires knowing the initial and final NAV values (present NAV). When calculating these returns, it makes no difference how long an investor has been invested in the fund.

What is the Absolute Return Formula?

The absolute return formula is straightforward to compute, making it ideal for investors. Only two numbers are needed to calculate this investment’s return. There is a present value, as well as an original investment. Calculating the absolute return follows this formula:

(Current value of the investment – Initial investment) / Initial investment) / 100 = Absolute return.

Let’s look at the case of Ms. Vani Kumar, a mutual fund investor who invested INR 1,50,000. The investment is now worth INR 2,50,000. Ms. Vani Kumar’s absolute return may be approximated using the following formula:

(250000 – 150000) * 100 is the absolute return.

66.66 percent is the total return.

Ms. Kumar’s mutual fund investment has returned 66.66 percent. However, this return does not take into account the time elapsed since the initial investment. It wouldn’t matter to Ms Kumar whether she had to wait another five years or fifteen years before she got this return. There’s no way to conclude this from a series of return values. As a result, during periods longer than a year, mutual funds typically compute annualised returns.

Read: Common Risks involved in Mutual Funds

Absolute Returns vs Relative Returns

A competent fund manager might be difficult for some investors to discern. Goodness might be hard to define since it relies on how the market is doing.

An asset’s or a portfolio’s “absolute return” is the sum of its total returns over a certain period. Using an index such as the S&P 500 to assess an investment’s return compared to the market’s (or other similar assets’) performance is known as a relative return. Alpha is another name for relative return.

On its own, absolute return does not tell us anything. To accurately compare an investment’s performance against other comparable ones, you must look at its relative return. Having a benchmark to compare your investment’s return to allows you to determine whether or not your investment is performing well or badly and take appropriate action.

Absolute Return

Asset classes, location, and economic cycles all create a well-balanced portfolio for fund managers that focus on absolute returns. This kind of portfolio manager places a high value on the interrelationships between the many elements that make up their holdings. The idea is to avoid being affected by wild fluctuations in the market due to a market event.

Unlike a regular mutual fund, an absolute return fund can generate positive returns by adopting unconventional methods. Absolute return fund managers utilise a variety of strategies, including short selling, futures, options, derivatives, arbitrage, leverage, and unusual assets. Unlike other performance metrics, returns are evaluated on their own, with just profits or losses taken into account.

The temporal horizon of an absolute return manager is limited. In most cases, these managers will not depend on long-term market patterns. Instead, they’ll focus on short-term price movements, both long and short.

Relative Return

Because actively managed funds are expected to outperform the market, relative return is useful for measuring their success. The relative return may be used to measure a fund manager’s performance. An investor can get the market’s return by purchasing an index fund with a low management expense ratio (MER).

For investors paying a manager for performance above the market, looking for a new fund manager may be worthwhile if that manager fails to provide a positive return over an extended period.

It’s not uncommon for fund managers to rely on established market patterns to attain their relative returns. For a year or more, they’ll conduct worldwide and in-depth economic research of individual firms to predict the direction of a stock or commodity.

Also Read: Learn About Commodity Futures for Smart Investment.

KEY TAKEAWAYS

• What an asset or fund earned over time is called its “absolute return.”
• An asset’s or fund’s relative return is the amount of money it has made over a certain period compared to a reference point.
• Managers of absolute return funds are more concerned with immediate returns, whilst those of relative return funds are more concerned with the long term.

Absolute Return vs Relative Return Example

A market cycle, such as a bull or bear, may be used to compare absolute and relative returns. In a bull market, a return of 2% would be considered terrible. The preservation of money would be regarded as a victory in a bear market, when many investors may be down by as much as 20%. When you put it that way, a 2 percent return isn’t so awful, is it? Based on the circumstances, the return might have a varying value.

In this case, the only return that counts is the 2% return. A 2% return is terrible in a bull market, but in a down market, it is excellent. It doesn’t matter how much money you make, but rather how much you make compared to what you’re making now.

Conclusion

However, when looking at returns over the long term, there are certain disadvantages to using the absolute return strategy since it ignores several potential influences on our investment. It’s a quick and easy approach to figuring out returns, but in the actual world, it should be used in conjunction with other methods like total returns or compound annual growth rates. To increase your portfolio’s risk-adjusted return while achieving a greater return rate with the least volatility, you need to include absolute return, for which you can use Nuuu absolute return calculator.