Absolute Return in Mutual Fund: Meaning, Working & Features

Suppose around a year ago; you invested in the shares of Company A when it was trading at Rs 120 per share. Today, let’s assume those shares are quoted at Rs 200 per share. Your investment value has risen in this year, but how much? In absolute terms, this works out to be Rs 80 per share, hence the term absolute returns. A similar concept applies to mutual fund investments, too, as this article will seek to explain.

What is Absolute Return?

Absolute return is the gain or loss from an investment; you calculate it by subtracting the price at which the investment was made from the current value of the investment over a certain period. This return, positive or negative, is also expressed as a percentage.

How do Absolute Returns Work?

Absolute returns are also called total returns, calculated by comparing the initial sum invested with the current value of the investment. Since the tenure of the investment is not considered, it is not always a reliable indicator of how good the gains are. For instance, you may have invested in a fund that generated absolute returns of 20%. But were those returns over one year or five years? If it was one year, 20% returns are likely to be decent, but over five years, those returns are probably not too good.

Example of Absolute Return

Assume that you have purchased units of a mutual fund at a net asset value (NAV) of Rs 100; after five years, NAV rises to Rs 140. Your absolute return over this period is 40, which in percentage terms will translate into 40%.

This is what the calculation will look like:

(Current Value of the Investment – Actual Investment)/Actual investment X 100 = Absolute return

Thus, (140-100)/100*100 = 40%

The Features of Absolute Returns

In mutual fund investing, absolute returns are gains or losses from a mutual fund investment after taking into account the initial sum invested as compared to the current value of that investment. Furthermore, unlike annualised returns, absolute returns do not consider the tenure of the investment. As a result, this method of calculating returns becomes challenging to use when comparing two investments.

Importance of Absolute Returns

Absolute returns are simpler to calculate than annualised returns and are typically not impacted by market volatility too much. They also tend to work better when the returns are calculated over a shorter period, say, less than a year.

When to Conduct Absolute Return Analysis?

Absolute returns can be considered when investors are willing to take on some risk in exchange for the potential to earn higher returns. Some absolute return strategies can include short selling, derivatives, and arbitrage, to name a few. In absolute return analysis, only gains or losses from the investment are considered; the investment is not likely to be evaluated against any other parameter.

To conclude

Depending upon the nature of the scheme, its tenure, and return expectations, you can decide whether absolute returns is the right method to help you evaluate your investment.

FAQs

What is Absolute Return in Mutual Fund?

An absolute return is the difference between the initial investment in a mutual fund and the current value of that investment over time, often expressed as a percentage. This return can either be positive (gain) or negative (loss).

How is Absolute Return calculated in Mutual Funds?

The formula to calculate Absolute Return in Mutual Funds is as follows:

Absolute Return = (Current Value of Investment – Initial Investment) / Initial Investment X 100

Is there a reference period for the calculation of absolute return?

Since there is no reference period for calculating absolute return, it becomes difficult to determine whether the returns generated from the investment are good.

Can absolute return be used for the comparison of two different investments?

Since the calculation of absolute returns does not consider the investment’s duration, it does not indicate how fast the investment grew or fell. Thus, this method is not used to compare two different investments.