Definition of absolute return
The term absolute in a mathematical sense refers to the numerical value of a number without its sign. For example, the absolute value of -7 is 7.
Absolute return in the financial context has a similar connotation. It refers to investment strategies which target a return that is above zero, and in some cases, above a positive hurdle rate such as Libor. The hurdle rate is an investment performance numerical value, which is used as a target to be beaten by a portfolio manager.
Absolute return can also refer to the total return (that is total gain or loss) of a portfolio or fund, as opposed to its relative return (that is relative gain or loss) against a benchmark. It is called relative because many mutual funds’ performance is benchmarked against an index. However, we will use the former definition in this glossary.
The vicissitude of asset returns - such as in equities where returns can range from very large positive to very large negative numbers - has resulted in an industry, which primarily resides in the hedge fund world, that promises to deliver absolute returns to its investors. These are returns that supposedly remain positive under all market conditions and cycles, and are hence also referred to as returns that are “uncorrelated“ with the overall market. The reality of it is that not many funds have been able to provide consistently positive returns irrespective of market conditions.
Hedge funds have traditionally been referred to as an absolute return strategy industry per the above definition. True to its form, the various hedge fund strategies had collectively delivered positive returns on average year after year, at least since the late 1990s.
However, they collectively delivered negative returns in 2008. This resulted in many investors losing confidence in hedge funds as an absolute return strategy, and hence they fled the industry by the hordes. From its peak of about $2.5 trillion in early 2008, the industry’s assets under management had fallen to about $1.6 trillion in 2009.