What Is the Absolute Return Index?

The term absolute return index refers to a stock index designed to measure absolute returns on investments in hedge funds. Hedge funds are considered alternative investments that use pooled funds to earn returns for their investors. 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.

Key Takeaways

  • The absolute return index is a stock index designed to measure absolute returns on investments in hedge funds. 
  • The index compares an individual hedge fund's performance against the hedge fund market as a whole. 
  • It is a composite index made up of five other indexes.

How the Absolute Return Index Works

Hedge funds are alternative investments that pool money together from different investors. These investments normally employ riskier investment strategies and investments that increase the chances of losses. Because they require a larger initial investment, they target accredited investors rather than the average investor. These funds use the absolute return approach to investing.

Some hedge funds 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% 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. 

With an. 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 products and determine profits and risks.

Investors may also 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.

Hedge fund investors can use the hedge fund absolute return index to measure the returns of their investments.

Absolute Return Index vs. Other Factors

Investors have other factors they can consider outside of indexes in order to compare funds. These 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.

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 (ROI), 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.

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.