Absolute return
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Absolute Return
The return that an asset achieves over a certain period of time. This measure looks at the appreciation or depreciation (expressed as a percentage) that an asset - usually a stock or a mutual fund - achieves over a given period of time.
Absolute return differs from relative return because it is concerned with the return of a particular asset and does not compare it to any other measure or benchmark.
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In general, a mutual fund seeks to produce returns that are better that its peers, its fund category, and/or the market as a whole. This type of fund management is referred to as a relative return approach to fund investing. As an investment vehicle, an absolute return fund seeks to make positive returns by employing investment management techniques that differ from traditional mutual funds.
Absolute return investment techniques include using short selling, futures, options, derivatives, arbitrage, leverage and unconventional assets.
Alfred Winslow Jones is credited with forming the first absolute return fund in New York in 1949. In recent years, this so-called absolute return approach to fund investing has become one of the fastest growing investment products in the world and is more commonly referred to as a hedge fund.
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Absolute return
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Absolute return
The absolute return or simply return is a measure of the gain or loss on an investment portfolio expressed as a percentage of invested capital. The adjective absolute is used to stress the distinction with the relative return measures often used by long-only equity funds[1] that are not allowed to take part in short selling.
The hedge fund business is defined by absolute returns. Unlike traditional asset managers, who try to track and outperform a benchmark (a reference index such as the Dow Jones and S&P500), hedge fund managers employ different strategies in order to produce a positive return regardless of the direction and the fluctuations of capital markets.[2] This is one reason why hedge funds are referred to as alternative investment vehicles (see hedge funds for more details).
Absolute return managers tend to be characterised by their use of short selling, leverage and high turnover in their portfolios. [3][4]
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Contents
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Short selling
Suppose that a manager thinks the share price of company A will go down. Then he can borrow 1000 shares of company A to his prime broker and sell them for (say) 10 USD per share. The immediate gain for the manager is 
USD. If (say) after a week the share price of company A drops to 9.5 then the manager buys 1000 shares, paying 
USD, and gives the shares back to his prime broker. He thus ends up earning a return of 
. If his prime broker asked a 2% interest rate for borrowing the shares then the net gain of the manager is 
.
Leverage
Sometimes a strategy gives a positive return but it is a very tiny one. Therefore, a manager can use leverage to magnify his return. For example, a long-short manager can deposit 100M with his prime broker in order to buy 200M of shares and simultaneously sell another 200M of shares, which gives a leverage ratio of 
. As another example, a manager can borrow money from a country at an interest rate of 2% and reinvest the amount on another country that pays 4%, thus earning the spread 
(this is called carry trade). If the manager has a leverage ratio of (say) 5 then his return is not 
but 
.
However, leverage also amplifies losses: if a manager has a market loss of 
in his portfolio and a leverage of 4 then his total losses are 
. Therefore, even small market losses are small can be disastrous when there is a huge leverage. According to the OECD, prior to the 2007 crisis, hedge funds in 2007 had an average leverage of 3 whilst investment banks had a leverage above 30.[5] With a leverage of 30, a market loss of 3.3% wipes out the entire portfolio whilst a leverage of 3 gives a total loss of 10%.
High turnover
Absolute-return managers are very active with their portfolios because they buy and sell shares more frequently than normal investors, which allows them to profit from short-term investment opportunities, typically lasting less than 90 days. The turnover is the rate at which managers rebalance their portfolios, and it strongly depends on the hedge fund's size: in 2008 hedge funds with less than 15M USD in AUM (Assets Under Management) had a 46.9% turnover per month whilst funds with over 250M USD in AUM had only 9.8%.[6]
See also
References
- ^ http://moneyterms.co.uk/absolute-return/
- ^ Robert A. Jaeger, "All about Hedge Funds", Mc Graw Hill, pp.3-4.
- ^ Jérôme Teïletche, "Les Hedge Funds", collection répères, pp.11-13.
- ^ Robert A. Jaeger, "All about Hedge Funds", Mc Graw Hill, pp.133-145 and 184-185.
- ^ http://www.oecd.org/dataoecd/15/4/43319875.pdf
- ^ http://www.hedgefund.net/dailyemailreports/HFN_Fund_Removal_Study_42908.pdf
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