As a financial advisor, I spent many an afternoon helping clients understand (and even appreciate) their investment returns. When it comes to absolute and relative returns, which is best to help your clients achieve—and hopefully even exceed—their financial goals? Our answer might surprise you.
Many years ago, as a young financial advisor, I spoke with a frustrated client. His large cap growth fund was down 20% for the year, and he was angry with his fund manager. “Can you believe it?” he vented, “Not only is my fund down 20%, but the manager got a bonus for it!” I sympathized with my client’s disappointment, but then suggested we take a step back. The growth fund, after all, was a 5-star, highly rated fund. Not only that, but his manager had actually outperformed his peer group, whose average was down 23%. So, while my client’s returns were not ideal, they certainly were better relative to what others had experienced.
Which brings us to this month’s topic: relative vs absolute returns. When ﬁnancial advisors such as yourself are meeting with clients, establishing ﬁnancial goals, and setting expectations, how do you explain the diﬀerence in investment paths, and guide them to determine which is right for them?
First, let’s explain both relative and absolute returns in a way that a typical client can understand.
A relative return is the comparison of a portfolio’s return to some benchmark index (like with my client years ago, a large cap growth fund). In this circumstance, the portfolio manager must follow rules and guidelines (written in that huge prospectus no one reads…except Brad!) that also apply to the other large cap growth fund managers. A successful return is relative to how the others performed.
An absolute return is a measure of performance with no benchmark, just the return itself in isolation. Typically, this means striving for positive returns in all markets (which sounds great but see our example below to understand why it isn’t always). In this case, the manager has a more flexible mandate on their investments: they can explore large cap growth, large cap value, small cap, international, bonds, even cash. At the end of the year, the portfolio’s outcome is absolute. Whether up or down, the returns only matter in isolation.
Try this example with your own clients: let’s say a fund was down 15%. Is that a good return or bad one? In isolation, as an absolute return, it sure isn’t good because the return wasn’t positive. But in terms of relative returns, what was the benchmark? If it’s 2008 and the market is down 30%, that’s a great result.
So, which is better for your client’s portfolio: relative or absolute returns? Our answer is YES.
A ﬁnancial advisor’s job is to help clients achieve their ﬁnancial goals, and the best way to do this is to narrow the range of outcomes. When the large cap growth is up 30%, of course your client wants to be up 30%, but it is important to ensure that there is downside protection, too. That’s where we come in.
At Dynamic Alpha Solutions, our managers work to achieve both absolute and relative returns. Our multi-dimensional asset allocation approach (we’ve said this before, but it bears repeating) aligns diﬀerent methods and styles to provide true diversiﬁcation. We leverage strategic, tactical, and alternative allocation styles, as well as quant, fundamental, and technical disciplines. By selecting from a broad range of strategies, we work toward our main goal: to narrow the range of outcomes.
Are you an Individual Investor?
If you’d like to be introduced to a Certified Multi-Dimensional Advisor or have a conversation with us about your goals
Of course, if asked, your client would say they want relative performance in the good times, and absolute performance in the bad times. And while that’s impossible to guarantee, in narrowing the range of outcomes, Dynamic Alpha Solutions helps you protect your clients’ portfolios so they can reach their long-term goals. Our managers employ diﬀering time frames for their investments: some invest for the short-to-intermediate term, while others focus on longer time frames. The purpose is to avoid being gravely aﬀected by wild swings in the market. By relying on both relative and absolute return strategies, we attempt to safeguard against extreme scenarios and outcomes. The truth is that real diversiﬁcation means that there is usually something in your portfolio you may not like—and this is on purpose.
In the end, an educated client is a happy client. (Yes, great returns also make for happy clients.) You can help them understand that some returns may be way up relative to others, and that is great—while other returns will be up only 12% when the market is up 20%, and that’s ok, too. This is how you build a successfully diversiﬁed portfolio. And this is how we help. After all, Dynamic Alpha Solutions was founded by ﬁnancial advisors, for ﬁnancial advisors. We’ve also had to answer for performance, explain our portfolios, educate our clients. And now, we’re here for you: to help you solve problems, provide expertise, diversify portfolios, and oﬀer your clients the highest level of investment services.