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 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&P 500), hedge fund managers employ different strategies in order to produce a positive return regardless of the direction and the fluctuations of capital markets. 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.

Although absolute return funds are sometimes considered not to have a benchmark, there is a common one: the funds should do better than short-dated government bonds (e.g. T-bills in the United States). For example, if such "cash" instruments yield 15%, at the same time a certain fund returns 5%, that would be considered not very good. In the case where the cash rate is close to zero, such as the early 2010s decade, this makes little difference.

Suppose that a manager thinks the share price of company A will go down. Then he can borrow 1000 shares of company A from his prime broker and sell them for (say) 10 USD per share. The immediate gain for the manager is $1000\times 10=10,000$ USD. If (say) after a week the share price of company A drops to 9.5 then the manager buys 1000 shares, paying $1000\times 9.5=9,500$ USD, and gives the shares back to his prime broker. He thus ends up earning a return of $(10,000-9,500)/10,000=5\%$ . If his prime broker asked a 2% interest rate for borrowing the shares then the net gain of the manager is $5\%-2\%=3\%$ .

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