Absolute Return and Relative Return: What’s the Difference?

Investors rely on absolute return to define how an asset or portfolio performed over a certain period. Relative return is the difference between the absolute return and the performance of the market. Traders commonly use a benchmark, like an index, to accurately measure their investment’s return when compared to the market.

Key Takeaways

• Absolute return is what an asset or fund returned over a certain period.
• Relative return is the return an asset or fund achieved over time compared to a benchmark.
• Absolute return fund managers are focused on shorter-term results, whereas relative return fund managers are geared toward market performance.

Absolute Return

Fund managers who measure their performance in terms of an absolute return develop a portfolio diversified across asset classes, geography, and economic cycles. Such managers pay attention to the correlation between the components of their portfolios.

An absolute return fund is positioned to earn positive returns by employing techniques that are different from a traditional mutual fund. Absolute return fund managers use short selling, futures, options, derivatives, arbitrage, leverage, and unconventional assets.

Absolute return managers have a short time horizon. Most of these managers will not rely on long-lasting market trends. Rather they’ll look to trade the short-term price swings, both from the long as well as the short side.

Relative Return

Relative return is a way to measure the performance of actively managed funds, which should earn a return greater than the market as compared to a benchmark, or index, such as the S&P 500. The relative return is a way to gauge a fund manager’s performance. For example, an investor can always buy an index fund that has a low management expense ratio (MER) and receive the market return.

Many fund managers who measure their performance by relative returns lean on proven market trends to achieve their returns. They’ll perform a global and detailed economic analysis on specific companies to determine the direction of a particular stock or commodity for a timeline that typically stretches out for a year or longer.

Important

Relative return is also called alpha, one of five popular technical investment risk ratios. 

Example

One way to look at absolute return versus relative return is in the context of a market cycle, such as bull versus bear. In a bull market, 2% would be seen as a horrible return. But in a bear market, when many investors could be down as much as 20%, just preserving capital is a triumph. In that case, a 2% return doesn’t look so bad. The value of the return changes based on the context.

In this scenario, the 2% would be the absolute return. Relative return is the reason why a 2% return is bad in a bull market and good in a bear market. What matters in this context is not the amount of the return itself, but rather what the return is relative to.

What Is a Fund Manager?

A fund manager helps investors define the holdings within their portfolios. Knowing whether a fund manager is doing a good job can be a challenge for some investors and commonly depends on how the rest of the market has been performing.

What Does Alpha Mean to Investors?

Alpha (α) is a term used in investing to describe an investment strategy’s ability to beat the market.

Why Is the S&P 500 a Popular Benchmark?

The S&P 500 Index includes approximately 500 leading U.S. publicly traded companies that focus on market capitalization. The index is considered one of the best gauges of large U.S. stocks.

The Bottom Line

Financial managers or advisors aim to earn absolute returns and generate positive returns annually without regard to an index or benchmark. Fund managers, such as retirement or mutual fund managers, seek relative returns that aim to beat an index like the S&P 500.