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Definition; 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
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Why Absolute Return is Critical to Long Term Investor SURVIVAL
It's important that you understand the impact that a bear market has on your capital. The give and take of your investment capital is not equal. If you placed $100 into an investment and it declined 50% to $50, what is the rate of return you would need to earn back your original investment of $100? Once you lose money, it takes a much greater return on the funds you have left to recapture your original investment. In this case, you would need a 100% gain on the remaining $50 to recapture your original $100 investment. These break-even percentages are shown in the table below, the Mathematics of Declines and Advances.
Mathematics Of Declines And Advances
| Decline Amount |
Advance Required to Breakeven |
| 25% |
33% |
| 33% |
50% |
| 50% |
100% |
| 75% |
300% |
| 90% |
900% |
Using the Mathematics of Declines and Advances, the table below calculates previous bear market break-even points and highlights the painful effects that a declining market can have on your investment capital.
Bear Market Break-Even Analysis
| Bear Market |
Duration |
% Decline |
To Breakeven |
| Sept. '29 - June '32 |
33 months |
86.7 |
25.2 years |
| July '33 - Mar. '35 |
20 months |
33.9 |
2.3 years |
| Mar. '37 - Mar. '38 |
12 months |
54.5 |
8.8 years |
| Nov. '38 - Apr. '42 |
41 months |
45.8 |
6.4 years |
| May '46 - Mar. '48 |
22 months |
28.1 |
4.1 years |
| Aug. '56 - Oct. '57 |
14 months |
21.6 |
2.1 years |
| Dec. '61 - June '62 |
6 months |
28.0 |
1.8 years |
| Feb. '66 - Oct. '66 |
8 months |
22.2 |
1.4 years |
| Nov. '68 - May '70 |
18 months |
36.1 |
3.3 years |
| Jan. '73 - Oct. '74 |
21 months |
48.2 |
7.6 years |
| Nov. '80 - Aug. '82 |
21 months |
27.1 |
2.1 years |
| Aug.. '87 - Dec. '87 |
4 months |
33.5 |
1.9 years |
| July '90 - Oct. '90 |
3 months |
19.9 |
0.6 years |
| March '00 - Sept '02 |
30 months |
47.3 |
????? |
Did you know that you would financially be better off to never lose money in any one year, and to only achieve half of the market's returns in the positive years?
Let us explain how this is possible. In the following table, we calculate the minimum return needed to break even with an absolute return strategy as compared to a buy-and-hold strategy. The absolute return strategy never loses money in any year. When the market has a negative year, the absolute return egy has a 0% or no loss year. So if the absolute return strategy never loses money in the negative years, what percent of the gains does the absolute return strategy need to capture in the positive years to equal the same average rate of return as a buy-and-hold strategy? We also calculate the break-even point needed if your losses in the down years were half the losses of the buy-and-hold strategy. The table below displays the year-to-year results of this analysis.
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NASDAQ 100 |
NASDAQ 100 |
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NASDAQ 100 |
Absolute Return |
Absolute Return |
| Date |
Buy & Hold |
No Losing years |
50% Of Losing Years |
| 1990 |
-10.41% |
0.00% |
-5.21% |
| 1991 |
64.99% |
24.91% |
41.19% |
| 1992 |
8.86% |
3.40% |
5.62% |
| 1993 |
10.58% |
4.05% |
6.70% |
| 1994 |
1.51% |
0.58% |
0.96% |
| 1995 |
42.54% |
16.30% |
26.96% |
| 1996 |
42.54% |
16.31% |
26.96% |
| 1997 |
20.63% |
7.91% |
13.08% |
| 1998 |
85.31% |
32.70% |
54.06% |
| 1999 |
101.95% |
39.08% |
64.61% |
| 2000 |
-37.65% |
0.00% |
-18.83% |
| 2001 |
-32.64% |
0.00% |
-16.32% |
| 9/30/2002 |
-47.66% |
0.00% |
-23.83% |
| Break Even Point |
38.33% |
63.37% |
If you never lost money in the down market years, you would only need to capture 38.33% of the gains in the positive market years to equal a buy-and-hold position in the Nasdaq 100 index. More realistically, if your losses in the down market years were half the Nasdaq's losses, you would only need to capture 63.37% of the Nasdaq's gains in the positive market years to equal a buy-and-hold position.
The point we are making is that you don't need to equal or outperform the performance of the market in the positive market years if you protect your capital in the down market years. Protecting your capital in the down market years has an exponential effect on growing your capital over time. The objective with any money management strategy should be to reduce risk and maximize returns — with risk reduction being the most important factor. All other things being equal, you want to invest in the least volatile, highest reward, lowest risk strategy possible.
You may be reading this today because you are tired of giving all of your own assets, or your client's assets, away to a bear market. You may even be in the position where your retirement has been diminished to the point of having to change your retirement plans. Whatever the reason, you have probably come to the same conclusion I have that there is another way to grow and protect your assets. |
