August 21, 2014

Absolute Returns Explained

Absolute returns and Absolute returns funds in particular aim to produce a better return on capital regardless of whether a market is on the rise or fall. Just like ‘spread betting’ allows traders to benefit from falls or rises in the markets, absolute returns works in a similar way.

Absolute return Fund managers usually employ long and short trades, depending on whether they think the market will rise or fall. As a type of investment that looks to prevail in the face of economic volatility, absolute returns can help to diversify a portfolio.

They differ from the more common type of funds that are deemed ‘relative returns’. It is these funds that aim to surpass a set benchmark such as a market index (e.g. FTSE 100). In this case, relative return funds would be relative to the FTSE 100 index, so a good performing fund in a falling market would still fall, but just not as sharply as its benchmark. However, because of the long and short positions available to an absolute returns fund manager, they may well have managed to maintain or even grow their fund despite the fall in the markets.

But the big caveat of absolute returns is that usually if the market sharply rises, then they typically don’t perform as well as relative return funds.