In finance, the term absolute return refers to a measure of investment performance. This measure indicates the actual gain or loss in the value of an investment, investment portfolio or an investment fund.
Absolute returns differ from relative returns, which indicate the performance of investments in relation to the performance of benchmarks (such as market indexes).
The term is most widely used in relation to investment funds which have a clear benchmark for returns (the absolute return benchmark) which should be achieved within each investment term (1 year, for example). These investment funds aim to achieve capital gains equal to or higher than the absolute return benchmark. The absolute return benchmark is typically shown as a percentage of invested assets. For example, a fund may aim to achieve a 3% capital gain per annum.
Funds which use absolute return thresholds are known as absolute return funds. Relative return funds, on the other hand, use a trailing threshold which follows an index or another fund. For example, a relative return fund may aim to achieve capital gains which are 3% higher than the gains in a major stock index, rather than a 3% capital gain on the original value of its shares.
Example of a relative return: You buy 10,000 shares in a relative return fund for 5 Swiss francs per share. The fund aims to outperform the Swiss Performance Index (SPI) by 2%. Over the course of one year, the SPI falls by 5%. If the fund managed to beat the market and meet its benchmark of 2% above the SPI, your shares would still lose 3% of their value (-5% SPI rate + 2% relative return benchmark) or 0.15 francs per share. You would make a capital loss of 1500 francs.
Example of an absolute return: You buy 10,000 shares in an absolute return fund for 5 francs per share. The fund aims to achieve an absolute return of 2%. Over the course of one year, the SPI falls by 5%. If the fund managed to beat the market and meet its benchmark of 2% absolute return, your shares would be worth 2% more (0.1 francs per share) than they were at the beginning of the investment term. You would make a capital gain of 1000 francs.
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