Absolute & Relative Returns – Meaning, Calculation & Importance

In this article, we will discuss in detail about absolute and relative returns, their importance and how to calculate them.

Relative Returns

Relative returns refer to returns as compared to a benchmark index in the country. It is the difference between the absolute return and the market index return. Mutual funds aim to produce a performance which beats the benchmark.

Importance of Relative returns

• Can measure the performance of a fund during both bear and bullish markets
• Helps in identifying those funds that are providing better returns than the index
• Helps in making decisions
• Considers both bullish and bearish market trends
• Accounts for a long-term time horizon

When to Use the Relative Return Analysis?

Relative returns help investors in picking up those funds that are outperforming the market. Hence, if an investor wants to know the right time to switch to a new mutual fund, this analysis will help him derive the fund. For example – When a fund manager leaves and takes up another fund, then he/she can tell if the gain or returns are more than the old fund.

Absolute Returns

Absolute return is the return that the mutual fund has provided over a specified period. Whatever the returns that the mutual fund provides are the absolute return without comparing to any benchmark index. Here, the fund managers are also called as the hedge fund managers who aim to maximise the return using various strategies in the market for the investors irrespective of the market trends.

For example – If a mutual fund’ current value is Rs 10,000 and investment value is Rs 8,000, then the absolute return is (10,000-8,000)/8,000, which turns out to be 25%.

Importance of Absolute Returns

• Diversified portfolio for better returns
• The short-term time horizon for faster returns (a long-term is also an option)
• Not impacted much by the volatility of the markets
• Dynamic risk management
• The goal is always to provide positive returns
• Simple and straightforward to calculate

When to Use Absolute Return Analysis?

Absolute returns can be used when investors are looking to assume some risk in exchange for the potential to earn high returns. This is irrespective of the timeframe.

Example of Absolute and Relative Returns

1. For the funds with serial number 1-5, the returns mentioned are the absolute returns over three months, one year, three years and five years.
2. Relative Returns: Relative return of the mutual funds are calculated as below :

Relative return for Axis Long Term Equity Fund and Nifty index.
Relative return 3 months : (0.5%-0.4%) = 0.1% 1 year : (21.6%-16.3%) = 5.3%
3 years : (9.1%-5.8%) = 3.3%
5 years : (22.8%-12.2%) = 10.6%

Here, we see that the Axis Long Term Equity has outperformed the Nifty over all the time, and hence, can be considered as a good fund.
Similarly, for SBI Magnum Tax Gain scheme, which has underperformed for three months and has been at par for a year, it can be considered a long-term bet with returns at 5.2% (17.1%-12.2%).

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