Absolute Return Investing vs. Relative Performance

By Larry Comstock, with contributions by Genevieve Valentine

Almost all managers evaluate performance against the Dow Jones Industrial Average or the S&P 500. Is there another way? Absolute Return Investing is about making a profit in any environment. Obviously, no one can guarantee a profit in any investment, let alone in all financial environments. However, it is possible to construct a portfolio or asset allocation model that optimizes an investor’s opportunity to potentially achieve positive returns. Further, this allocation modeling allows the investor to use volatility as a “friend”, not as a “foe”.

Various events which occurred in the last decade have reinforced the negative impact volatility has had on the stock market’s performance. This kind of volatility has caused some investors great heartache, and at the same time has created billionaires. How has this happened? As John Valentine says, “Absolute Return Investing is not about comparing your performance to the Dow Jones Industrial Average or any other barometer, but rather to focus on generating positive returns regardless of the stock, bond, or real estate market. Achieving this goal requires a unique approach to portfolio modeling.” How can this be achieved?

• First, an investment advisor will need to identify positive returns through a variety of multiple strategies. Not only by buying blue chip, small cap, and international stocks and calling it diversification, but by identifying totally different strategies that move differently; but, eventually achieve positive results during different economic climates.
• Second, lowering portfolio volatility is needed. Although two different investments may achieve the same return at the end of the year, an investor (with the guidance from their financial advisor) often feels more comfortable with an investment that gets optimal results with the least amount of ups and downs.
• Third, in the same manner that stocks and bonds tend to limit risk and market exposure when combined in a portfolio, limiting risk can also be obtained by lowering the correlation within a portfolio allocation. This can be achieved through identifying assets that have either negative or low correlation.
• Fourth, an investor needs to use market volatility to their advantage, rather than letting volatility abuse their portfolio. Therefore, when world events drive the stock market down, those same forces have a positive impact on a different strategy. Seeking positive return investments in a variety of strategies, selecting strategies with lower volatility, and enhancing diversification through the selection of investments with low or no correlation, will achieve your goal of generating positive absolute return potential. John Valentine adds, “This model can lower your portfolio’s volatility and will enhance your overall portfolio diversification.”
  

Examples of this may include: 1.) Strategies that monitor the worldwide weather scenario to determine if the price of grains may be ready to escalate. 2.) Selling covered calls to generate income and help reduce the exposure in your stock portfolio. 3.) Trading energy ETFs, stocks, or contracts based on shortages and geopolitical concerns. 4.) Using straddles to benefit from short versus long term price movements. 5.) Trading currencies based on government interest rate movements, the largest market in the world. “Essentially, strategies that trade the Swiss Franc have little direct correlation with strategies that trade wheat against systems that trade the US stock market, hence true diversification. Ultimately, the best strategies come down to proper diversification and asset allocating”, added John Gardner. Although every individual investment strategy carries risk, your total portfolio does not have to carry the same amount of risk. John Valentine ended with, “This strategy can complement an existing portfolio, and not only reduce risk but use volatility to an investor’s advantage.” Please consult your financial advisor regarding your specific situation prior to implementing an investment plan. The information provided in this article is for educational purposes only and should not be considered a recommendation to buy or sell any security, or of a specific investment strategy. Past performance does not guarantee future results. Investing involves risk, including loss of principal.

The hypothetical examples provided in this article are for educational purposes only, and should not be considered a recommendation to buy or sell any security, or an endorsement of any specific investment strategy. Each investor's portfolio must be constructed based on the individual's financial resources, investment goals, risk tolerance, investing time horizon, tax situation and other relevant factors. Please discuss with your financial advisor before implementing an investment plan.

Diversification may help reduce, but cannot eliminate, risk of investment losses. Historical performance relative to risk and return points to, but does not guarantee, the same relationship for future performance. There is no assurance that by assuming more risk, you are guaranteed to achieve better results.