Absolute Return, Relative Return, Hedge Funds… what do this mean?

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In the last years, investment funds labels multiplied. Leaving aside some “exotic” denomination (that often are part of a marketing strategy, without indicating a true value proposal for shareholders), it is useful to understand the meaning of three “labels” you can often meet Absolute Return, Relative Return, Hedge Funds.

  • Relative Return funds are investment funds that measure the performance against a benchmark. Most investment funds are part of this category (even not every fund succeed in “beating the benchmark” – reason why many investors are switching to ETFs): the main disadvantage is that even if the fund has a better performance than the benchmark, it does not mean automatically a gain for investors. For example, if a fund invests in the real estate sector, and this sector loses 20% in a year, a fund that lose only 18% beats the benchmark.
  • Absolute return funds aim to obtaining a gain in any market condition. To reach this objective, the fund manager has a relevant freedom in the choice of investment (that can vary from monetary, bond, equity). The downturn is that in a bull market usually absolute return funds have lower performances than relative return ones, while in a bear market the performance is often quite low (often slightly negative). Therfore, many investor do not like very much this type of funds, considering risks not counterbalanced by gain perspectives, preferring for example bonds
  • Hedge funds aren’t a different category (they may be categorized as absolute or relative return funds), but since it’s a name you hear very often, it’s worth to explain what they are. Hedge funds is a private investment fund which is permitted to undertake a wider range of activities than other investment funds (e.g. buy derivatives or short sell). This means they can have bigger earnings, but also greater losses. For this reason, hedge funds are open to a limited range of investor, who have to meet strict requirements on income and net worth.

Leaving aside fund categories, it is important to highlight that results of an investment fund depends strongly from the fund manager, that needs to have over-average skill, ability (and luck), to reach over-average performances.

Original post (in Italian): Absolute Return, Relative Return, Hedge Funds: cosa sono esattamente?

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