Absolute return

The absolute return or simply return is a measure of the gain or loss on an investment portfolio, typically expressed as a percentage of invested capital. The adjective absolute is often added to stress the distinction with the relative return measure.

In recent years, so-called absolute return strategies have become popular. These strategies aim to always produce a positive absolute return regardless of the directions of financial market. Such absolute return strategies typically achieve this by investing the portfolio's assets in short-term cash and then taking opportunistic long positions and short positions in selected (groups of) securities without structurally being exposed to any particular market (segment) over time. In statistical terms, such absolute return strategies should have very low correlation with financial market performance.Of course, whether such portfolio actually delivers a positive absolute return depends on the skill of the portfolio manager in selecting profitable long and short positions. Many, though not all, so-called hedge funds employ absolute return strategies.

Absolute return strategies can be further characterised along several dimensions. The first is the direction of the positions taken: long-only, short-only, or both (aka long-short). Clearly, it is more difficult to achieve a positive absolute return with long-only or short-only strategies than with long-short strategies. Within the long-short strategies, a further distinction is whether the strategies is market-neutral or directional. Market-neutral strategies ensure that their exposure to the market, however defined, is neutral so that the portfolio should neither rise nor fall in value when the market rises or falls. Conversely, directional long-short strategies are strategies where the portfolio may have a net long or short exposure at a given point in time. As a result, such portfolios will rise or fall if the market rises or falls.

A second dimension to distinguish between different types of absolute return strategies concerns the nature of the analysis that gives rise to the positions. Commonly stated types are opportunity-driven, event-driven, (statistical) arbitrage, and macro. Event-driven strategies include strategies that aim to exploit M&A situations or distressed companies. Convertibles arbitrage is an example of an arbitrage strategy. Macro strategies aim to exploit opportunities based on macro-economic analyses by taking positions in interest rates, exchange rates, and equity indices across different countries or regions.

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