What is Absolute Return in a Mutual Fund and how does it work?

In a Mutual Fund, Absolute Return is related to your investment’s performance over time. The calculation method to determine the Absolute Return in Mutual Funds depends on the investment's time horizon. This approach is more relevant for funds with a time horizon of less than a year. However, one may use the calculation method to calculate returns for any Mutual Fund investment. So, let’s get started!

What is the Absolute Return in a Mutual Fund?

Absolute Return in a Mutual Fund is the percentage of gain or loss of a Mutual Fund investment during a period, irrespective of fluctuations in the stock market. Unlike regular calculation methods, the method of calculating Absolute Return focuses more on gain or loss over a period. The method simultaneously employs multiple asset classes and investment strategies.

By calculating returns in various market conditions, the Absolute Return in a Mutual Fund determines stability for investors with low-risk appetite. However, before calculating the returns of Mutual Funds, investors must thoroughly evaluate investment goals, performance history, risk management process, etc.

How does Absolute Return work?

When calculating Absolute Return in a Mutual Fund, one must consider the price of purchasing and selling the Funds. Then, divide the difference with the purchase price. The percentage of Absolute Return is the result multiplied by 100. Absolute Return is the most relevant when the investment horizon is less than a year. For instance, the method is used for calculating returns over a week, month, year, quarter or six months. All these are Absolute Returns.

The formula to calculate Absolute Return

Absolute Return = ((Present NAV – Initial NAV)/ Initial NAV) x 100

Example: An investor purchases 100 units of a Mutual Fund at the Net Asset Value of ₹ 10 and sells them at ₹ 15 NAV. The Absolute Return will be:

Sales price - Purchase price

= 15 - 10

= 5

Profit/Purchase price x 100

= 50%

In this example, the investor received an Absolute Return of 50%.

The Absolute Return calculation will make sense if the investor invests for under a year. For longer investments, computing the annualised returns will be more helpful. 

Significance of Absolute Return calculation in a Mutual Fund

• Positive returns: The primary goal of calculating Absolute Return in a Mutual Fund is to find the profit and loss in an investment regardless of market conditions. This goal-oriented strategy allows investors to grow and maximise their investment value over time.
• The advantage of portfolio diversification: Based on the Absolute Return in a Mutual Fund, investors can build diverse portfolios to achieve higher overall returns through different securities and asset classes. At the same time, it reduces the portfolio’s overall risk exposure, keeping the investor’s money safe and growing.
• Resilience to volatile market conditions: Absolute Return calculation is less susceptible to financial market volatility and fluctuations. A high degree of resilience lets investors stabilise their investment strategy while mitigating the impact of market volatility on their portfolios.
• Suitable for investments with different time horizons: Absolute Return helps calculate short and long-term gains, making them relevant to investors with different time horizons. Whether the investor seeks faster returns in a short period or maximum returns by staying invested for a longer term, calculating Absolute Return is useful for both.
• Minimum risk involved: Absolute Return calculation supports dynamic risk management strategies, allowing investors to adjust their asset allocations according to their risk appetite and market conditions. This high level of flexibility allows investors to adjust their portfolios for maximum returns at minimal risk to their investment capital.
• Easy calculation: Calculating Absolute Return is easy. A simple mathematical formula only requires comparing the Fund's initial NAV and present NAV. Investors can quickly calculate their investment's Absolute Returns without technical know-how.

Pros and Cons of Absolute Return calculation

Pros:

• By employing the Absolute Return strategy for calculating investment returns, the investor diminishes the element of volatility in their portfolio.
• Calculating return using this method lets the investor consider various platforms and sources of investment returns to maximise them.
• Absolute Return does not restrict investors to any traditional benchmark. They can diversify their holdings across various asset classes, enabling them to reduce the risks associated with a single asset class or platform.
• The strategy improves the risk-adjusted return in the portfolio, which is a crucial element for every investor.
• Investors can control their losses by setting a stop-loss limit. If they feel their investment is going in the wrong direction without yielding any return, they can withdraw their investment and save capital.

Cons:

• When comparing returns over different time horizons, Absolute Return does not serve as a dependable metric.
• Comparing different assets becomes difficult when calculating Absolute Return.
• Even if an investment delivers a positive Absolute Return, the ultimate gains may be negative. That is because the return calculation strategy does not consider inflation.
• The method considers all kinds of investments, including low and high-risk assets. Although all Mutual Fund investments have risks, disregarding them through the Absolute Return strategy fails to show accurate values.
• Assessing the outcome becomes challenging due to lack of a baseline return comparison.
• New investors may not have an idea about the Fund Manager’s performance. 

When looking for the best investment, the popularity of Absolute Return calculation in a Mutual Fund has increased significantly among investors. The calculation method helps choose investments that deliver profitable returns even during falling market conditions. Other benefits include risk management, portfolio diversification, stable returns and active management.