What is Absolute Return Index

The absolute return index is a stock index designed to measure absolute returns on investment.  The index was created to compare the performance of an individual hedge fund against the hedge fund market as a whole. It is a composite index made up of five other indexes.

BREAKING DOWN Absolute Return Index

Investors may use the absolute return index to compare one hedge fund to another. Due to the nature of hedge funds, and the various strategies they use to earn a profit, success can look different from fund to fund. Hedge funds can invest in just about anything, which further complicates the ability to compare funds based on their earnings.

The risk profile is another place where an investor may wish to compare one fund against another. There are various layers of risk associated with some investment funds. While one fund may have a more substantial return on investment, the risk may be higher. This added risk can be beneficial, as the profit will be higher if the investment pays off, but investors have the potential for higher losses if it does not.

With the hedge fund absolute return index, investors can easily discern the success or failings of a particular investment as it stacks up against the market as a whole and can do so without having to sift through the intricate details of each transaction. The absolute return index is only useful when dealing with the hedge fund market. Other markets, including mutual funds, stocks, and bonds have their individual metric systems to compare product and determine profits and risks.

Additional Metrics to Absolute Return Index

Some hedge funds will have a benchmark, or performance standard, which they are trying to achieve to be considered a success. Others will have a set rate which they aim to deliver. For example, a 20 percent return over 12 months may be regarded as very successful for a fund that invests heavily in real estate. This same return is not as auspicious for a fund that invests in a foreign currency. 

Other considerations for investors include the amount of fund capital available to invest and costs associated with managing the hedge fund. A hedge fund manager can review these different metrics and advise investors on the best markets for their investment. Depending on long-term goals and available capital, hedge funds may not be the best investment for everyone.

Due to the many intricacies of hedge funds, there are additional risks for the investor to consider. These risks include the need for funds to be tied up for long periods of time, large amounts of capital placed in a single venture with little diversification, and the use of borrowed money. All of these will increase the risk, but may also increase the reward.