Investing in mutual funds has long been a preferred method for individual investors to diversify their portfolios, manage risk, and seek returns from a broad range of assets. Among the many types of mutual funds available, one of the most intriguing and potentially rewarding types is the absolute return mutual fund.
These funds generate positive returns regardless of the market’s direction. In this article, we will explore what absolute returns in mutual funds mean, how they work, their benefits, risks, and much more.
What Does Absolute Return in Mutual Funds Mean?
Absolute returns in mutual funds refer to the gain or loss an investment achieves over a specific period, without comparison to a benchmark. Funds with an absolute return aim to generate positive returns irrespective of market conditions. It uses multiple strategies and different asset classes, such as stocks, bonds and derivatives, to stabilise it.
However, you must perform due diligence to ensure the fund aligns with their financial objectives and risk tolerance. Being market-independent, it is imperative to evaluate factors such as the fund’s past performance, investment approach and risk management before considering.
How Does Absolute Return Mutual Funds Operate?
After understanding the absolute return meaning, you must know how it works. Here is a comprehensive breakdown of how absolute return in mutual funds works:
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Direct Profit/Loss Calculation
The absolute return in mutual funds is based on the profit or loss of an investment over a stipulated period, considering the difference between its opening and final values.
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No Benchmark Comparison
Absolute return, in contrast to other performance metrics, measures investment performance independently, without referencing an external index or benchmark.
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Timeframe Agnostic
You can apply absolute return in mf in any investment period, from days to years. It provides performance assessment flexibility.
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Utility in Short-Term Investment
Since absolute return is not tied to a specific timeframe, it is a valuable metric for assessing short-term investments where the goal is to generate fast returns.
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Risk Assessment Tool
To assess risk, you can use raw returns by focusing on absolute return funds to analyse whether your investment strategy is performing effectively in isolation.
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Strategic Investment Decisions
Understanding absolute returns helps the investor make appropriate strategic decisions, particularly when selecting mutual funds or assets. It focuses on positive returns with no consideration for market trends.
What are the Benefits of Absolute Return Mutual Funds Investments?
When you are looking for what is absolute return in mutual funds, you must also have a look at its benefits:
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Consistent Returns
Absolute return funds aim for positive gains regardless of market ups and downs, making them attractive for investors seeking stability and predictable returns. These funds are suitable for those with a lower risk tolerance.
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Diversification
These funds diversify investments across various asset classes and employ multiple strategies, reducing portfolio risk. This approach helps cushion against losses in any single investment area.
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Lower Volatility
Absolute return funds typically exhibit less volatility than traditional equity funds. In these funds, hedging and risk management strategies are used to contribute to a smoother investment journey.
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Capital Preservation
These funds prioritise minimising losses, acting as a safeguard for capital. They are a suitable option for investors with a conservative approach and those who focus on preserving their principal investment.
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Potential for Higher Returns
Skilled managers can leverage alternative strategies and market inefficiencies to generate alpha or excess returns, potentially boosting overall portfolio performance beyond market averages.
What are the Challenges and Risks of Absolute Return Mutual Funds?
When looking for ‘what is the absolute return on mutual funds?’, it is important to consider the following challenges and risks:
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Hidden & Higher Fees
Absolute return strategies often have higher and less transparent fee structures than traditional investments, potentially affecting the overall return. Understanding the fee structure is crucial to assess whether benefits outweigh costs.
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Complexity
These strategies can be complex, making it difficult for investors to understand the underlying investment strategy and risk profile. Complexity makes it hard to evaluate performance and whether it meets investment goals.
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Limited Liquidity
Some absolute return strategies, particularly hedge funds, may restrict investor withdrawals, limiting liquidity. Lack of liquidity can make it difficult to access capital during times of financial stress.
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Manager Skill Required
Effectively managing absolute return funds requires a high level of skill from the fund manager to navigate complex strategies. Assessing their ability to deliver consistent positive returns while managing risk is essential.
Who are Absolute Return Mutual Funds Best Suited for?
After understanding what an Absolute Return Fund is, you can determine whether you fall into one of the following investor categories suited for absolute return mutual funds:
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Risk-Averse Investors
Those with lower risk tolerance may be attracted to absolute return funds since they seek profit regardless of the market direction.
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Conservative Investors
These funds are ideal for conservative investors as they focus on minimising losses and protecting capital.
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Goal-Oriented Investors
Absolute return allows investors to set specific goals and measure performance against those goals rather than market benchmarks. It is useful for evaluating long-term investments like retirement or college savings, helping investors fulfil their long-term goals.
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Investors Seeking Diversification
Absolute return funds can be a good alternative to traditional bond and stock funds, as they utilise a variety of instruments across different asset classes.
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Investors Planning for a Future Expense
These funds may suit those with a “known spending need in the future, such as a property purchase”. However, it is important to remember that even though these strategies attempt to secure gains in any market, they are not guaranteed, and you can still lose funds.
What is the Process to Invest in Absolute Return Mutual Funds?
Investing in absolute return mutual funds is similar to general mutual funds investment. However, it requires careful consideration of several factors. Here are the steps to follow:
- Research and Select a Fund: Analyse different absolute return funds based on performance, investment strategies, risk profile, and fund manager expertise.
- Understand the Fees and Expenses: Review the expense ratio, management fees, and any additional costs associated with the fund.
- Check Historical Performance: Evaluate past performance to understand how the fund has performed during different market cycles.
- Assess Risk Tolerance: Ensure the fund aligns with your risk appetite and investment goals.
- Invest Through a Trusted Platform: Use a reliable brokerage or mutual fund platform, like Torus Digital, to invest in the selected fund.
- Monitor Performance Regularly: Keep track of the fund’s performance and make adjustments as needed.
What are the Absolute Return Mutual Funds Tax Implications?
The following table highlights the absolute return in mutual fund tax implications:
| Type of Mutual Fund | Short-Term Capital Gains Tax | Long-Term Capital Gains Tax |
| Equity Funds | If you hold the units for less than 12 months, the gains will be taxed at 20%. | If you hold the units for 12 months or more, the gains up to ₹1.25 lakhs is tax-free. However, the extra gains will be taxed at 12.50% |
| Debt Funds | According to your income tax slab rate. | According to your income tax slab rate. |
| Equity-oriented Hybrid Funds (investing a minimum of 65% in equities) | If you hold the units for less than 12 months, the gains will be taxed at 20%. | If you hold the for 12 months or more, the gains up to ₹1.25 lakhs is tax-free. However, the extra gains will be taxed at 12.50% |
| Debt-Oriented Hybrid Funds | According to your income tax slab rate. | According to your income tax slab rate. |
How to Choose the Right Absolute Return Mutual Fund?
When it comes to choosing the right absolute return mutual funds, you must consider the following pointers:
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Fund Manager’s Expertise
Opt for funds managed by experienced and skilled professionals. A seasoned manager understands complex strategies and adjusts to market changes, maximising potential returns while managing risk effectively.
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Investment Strategy
Understand the fund’s strategies and ensure they align with your investment goals and risk tolerance. Understand how the fund aims to generate returns regardless of market conditions and verify strategy transparency.
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Expense Ratio
Select a fund with reasonable fees to maximise net returns. High expense ratios can significantly impact overall profitability, so compare costs across similar funds before investing.
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Performance Consistency
Scrutinise the fund’s historical performance across diverse market environments. Consistent performance indicates the manager’s ability to deliver returns regardless of market fluctuations, adding reliability.
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Risk Management Measures
Confirm the fund employs effective risk mitigation techniques like hedging and diversification. Strong risk management safeguards capital during market downturns and contributes to stable returns.
Final Words
Absolute return mutual funds offer investors a unique opportunity to achieve steady and positive returns across different market conditions. While they come with certain risks and complexities, they can be a valuable addition to a well-diversified investment portfolio.
Investors should carefully evaluate their risk tolerance, investment objectives and the fund’s performance before investing. With proper research and due diligence, absolute return funds can be a powerful investment option for wealth creation and capital preservation.
If you are looking to invest in these types of funds, use Torus Digital and avail the benefit of a seamless process and diversified portfolio!
