What is Absolute Return in Mutual Fund? Explained

When reviewing mutual fund performance, terms like “absolute return” represent a crucial metric. For many investors, these metrics can seem challenging at first glance. However, understanding them is key to making informed financial decisions.

One easy yet effective approach to measure the growth in your investment over a certain period is absolute return. Unlike other measures, it offers a basic performance picture free from consideration for time or market conditions. This makes it especially useful for short-term evaluations or comparing investments across different funds.

The idea of absolute return will be discussed in this article together with its formula and computation as well as when and how best to apply it.

What is the Absolute Return in Mutual Funds?

Absolute return, independent of time or market conditions, is the whole percentage gain or loss an investment makes over a certain period. This simple approach shows absolute terms of growth or shrinkage in your investment, therefore gauging performance.

The absolute return, for instance, would be 20% if you paid ₹1,00,000 into a mutual fund and its value rose to ₹1,20,000.

Absolute return, unlike measures like annualised or relative returns, emphasises just the whole change in value without regard to time. For example, annualised returns help to divide performance into annual numbers, therefore facilitating comparison of assets kept over different time frames. Conversely, relative returns gauge performance in respect to a benchmark index or other like investment.

The simplicity of absolute return is its key feature, but it also means it has limitations. Since it doesn’t factor in the time duration, two investments with the same absolute return can have drastically different annualised performances if one took five years and the other just one year to achieve those results. Despite this, absolute return remains a fundamental metric for quickly assessing an investment’s overall performance.

Formula and Calculation

The formula for calculating absolute return is straightforward:

Absolute Return=Current NAV – Initial NAVInitial NAV 100

Where:

• The Net Asset Value of the mutual fund at the conclusion of the investing term is known as current NAV.
• Initial NAV is the NAV at the time of purchase.

If you bought a mutual fund with an initial NAV of ₹100 and two years later the current NAV has increased to ₹140.

Absolute Return=140 – 100100 100=40100 100=40%

This means your investment generated an absolute return of 40% over the two-year period.

Simple to calculate, absolute return lets investors rapidly grasp the whole performance of an investment. For a holistic picture, though, keep in mind that it does not consider the time horizon; hence, combine it with other measures such as annualised returns.

When to Use Absolute Returns?

Understanding when to use absolute returns can significantly enhance investment decision-making and strategy development. This approach is particularly beneficial in various scenarios:

1. Comparing Different Investments: Absolute return is particularly useful when comparing multiple investments. It provides an easy approach to evaluate whether investment has produced superior profits by concentrating just on performance without considering market swings.
2. Evaluating Long-Term Goals: Absolute return lets investors know whether their investments are on course for long-term goals like supporting college or a retirement corpus. It makes tracking advancement towards these objectives easier.
3. Analysing Fund Performance: Absolute return lets investors evaluate other managed portfolios, hedge funds, or mutual funds. It shows the fund’s growth free from any connection to more general market conditions.
4. Assessing Risk-Adjusted Outcomes: Absolute return shows the performance of an investment more clearly since it considers the degree of risk involved. When weighing investments with comparable returns but different risk profiles, this is extremely helpful.
5. Customising Investment Strategies: Focussing on absolute returns helps investors to match their plans to their financial objectives and personal risk tolerance. This strategy gives more freedom since it does not depend on comparing returns to a market index or benchmark.

By integrating absolute return analysis into their evaluation process, you can gain a clearer understanding of your investments’ performance and make more informed decisions to achieve your financial goals.

Advantages of Using Absolute Returns

Absolute returns are a straightforward way to assess investment performance, offering clear benefits but also having notable limitations. Here’s a concise look at their pros and cons:

Advantages of Using Absolute Returns	Limitations of Absolute Returns
Simple and Easy to Understand: Absolute returns focus solely on the percentage increase of an investment, making it easy for beginners.	Ignore the Time Factor: Absolute returns do not account for the investment duration, making it difficult to assess efficiency over time.
Direct Comparison: Enables a clear comparison of performance across investments without considering compounding or time.	Limited Context: Lacks benchmark comparison or market performance context, making it hard to evaluate relative success.
Transparency: Provides an unaltered view of an investment’s raw performance without adjustments for duration or compounding.	Misleading for Long-Term Investments: Neglects the compounding effect, providing an incomplete picture for long-term growth assessments.
Useful for Short-Term Investments: Helps in evaluating specific goals and short-term performance effectively without complex calculations.	Not Suitable for Comprehensive Evaluation: Ineffective for evaluating long-term investments or understanding continuous growth over time.

Absolute returns are a practical tool for short-term analysis and decision-making but require complementary metrics like annualized returns to provide a full picture of investment performance, especially for long-term goals.

Absolute Return vs. Annualised Return

When evaluating investment performance, understanding the differences between absolute return and annualised return is crucial. Both metrics offer valuable insights, but they serve different purposes and are suited to different types of analysis. Here’s a detailed comparison:

	Absolute Return	Annualised Return
Definition	Calculates, independent of period length, the overall percentage change in the value of an investment.	Displays, with consideration for compounding, the average annual increase rate of an investment.
Time Factor	Does not consider the time duration of the investment.	Adjusts returns to reflect annual growth over the investment period.
Perspective	Provides a raw performance metric without time adjustment.	Offers a time-adjusted measure, reflecting the compounded growth rate.
Suitability	Useful for understanding overall profit or loss.	Appropriate for long-term investments since performance evaluation depends much on time.

Although they are both measures of investment success, absolute return and annualised return differ greatly in their emphasis and computation.

Conclusion

Calculated as a percentage, absolute return in mutual funds offers a clear assessment of the whole gain or loss of an investment over a designated period. Although it provides obvious information on the performance of an investment, it is crucial to keep in mind that it does not consider time or compare against market benchmarks.

Understanding absolute return allows you to match your financial goals with your investment plan and enables you to make wise decisions and approach your investment path more actively.Take control of your financial future with a financial management app. Visit PowerUp Money and download the app today!