The Irrelevant Absolute and Relative
A few days ago, one of our partners received an email from her client Ashish. The email in question was a second opinion on his portfolio given by India’s biggest wealth management firm. The name is not important but just in case you are curious, it has a few letters in its name. You can either go the Sherlock Holmes way to figure out the name of the firm or better yet focus your mental energy on understanding the contents of this post.
While Ashish completely trusted the partner, he was obliged (I don’t know if this is the right word but never mind, we will assume it is) to take a second opinion as he was doing some work with the wealth firm. But he was very clear, I will only do what my financial coach (the partner) tells me to do. With that intent, he forwarded the analysis, some of which I reproduce here for your consumption.
- Portfolio is well diversified across all categories, fund managers and is extremely well managed.
- 100% of the equity portfolio are in relative return strategies which tend to be benchmark oriented. We would recommend some absolute return strategies through AIF/PMS ideas with our preferred managers (xxxxxus, xxxxx Capital – again the names of these PMS-es don’t matter) for Alpha Generation.
Well, I loved the first point of the above text where the firm was honest enough to acknowledge that the portfolio was extremely well designed, constructed and handled.
Well, if it is managed extremely well, does it really warrant a change?
In the same breadth, the following words were also used – relative return strategies, benchmark oriented, absolute return strategies, and Alpha Generation.
How many investors understand relative return and absolute return strategies? Not many. Forget investors, how many financial professionals can explain in a simple way what they mean? Again, the answer is not many.
The objective of this post is to demystify these jargons and to get across the main point – Both are irrelevant. Absolute and Relative Return Strategies – Both don’t matter.
As I am writing this, I have a feeling there will be a Part II of this post. I am not entirely sure, but we will see how it goes.
Now that you know the moral of the story, let’s dive into what these (relative return and absolute return strategies) mean.
Absolute return simply means the return the portfolio delivers over a period of time.
In simple terms, the products that use absolute return are telling you the following – we can do what the hell we want to do. We can take whatever risk with your money that’s possible. Thus, there are fancy lines used to explain absolute return strategies – Absolute return strategy is one that aims to deliver a positive (absolute) return to investors, regardless of whether the markets are rising or falling, although a positive return is not guaranteed.
Another gem – The Absolute Return Strategy is a top-down macro strategy that seeks to identify and exploit inefficiencies between markets, regions and sectors. These funds globally can use short selling, futures, options, arbitrage, derivatives, leverage, and any assets.
Absolute return products and strategies are what brought about the Global Financial Crises. The hunt or desire for returns at the cost of anything/everything brought the global financial services industry to its knees. Guess the industry participants still haven’t learnt a lesson and are still pitching absolute return products although the flavours and packaging are different now.
With this, I rest my case on the Absolute Return Products front. The lesson is – Such products are injurious to your financial life. Rather Protect your financial life from such products and people.
However, there is a nuance about the words “absolute return” that I wish to highlight without reference to any absolute return funds or products or strategies. In fact, the reference I am about to share is the complete opposite of absolute return funds and products (Hint – HappyRich). The answer is given at the end of the post.
Let’s now understand the Relative Return part.
Relative Return is the return an asset achieves over a period of time compared to a benchmark. The relative return is the difference between the asset’s return and the benchmark’s return. Relative Return is also known as Alpha in the context of active portfolio management.
For example, a large cap fund might have their benchmark as Nifty 100. This means this fund’s performance will be compared to that of Nifty 100.
How is this relevant in the context of your life’s benchmark?
It’s actually not because the only BENCHMARK /GOALS that matters is YOURS.
In the book Adaptive Asset Allocation, Authors Butler, Philbrick and Gordillo share these gems that you might want to memorize.
- Those who judge their portfolio by its performance relative to some narrow benchmarks are focusing on an issue that is largely irrelevant to their ultimate financial success.
- The only benchmark that you should care about is one that indicates whether or not you are on track to accomplish your financial goals.
- Risk is measured as the probability that you won’t meet your financial goal. Investing should have the exclusive objective of minimizing this risk.
Read the above 3 points again. Note them down somewhere if you need a reminder.
Smart salespeople know that we learn what we want (aka Mimesis) by watching other people. First, by seeing what our parents, siblings, and peers want, followed, eventually, by what people on social media want.
We co-opt other people’s goals because it’s very hard to get clear about our own goals.
You hear your wealthy friend talking about how important it is to own PMS/AIFs, so you think you should go buy them, too.
You hear someone talking about Gilts, now you want Gilts too.
You hear about all the cool kids investing in start-ups and all the fancy people buying Tesla’s. Maybe you should do that too.
Here’s the thing: nothing anyone else owns, wants, or does, has anything to do with you. Because they aren’t you.
You, and only you, are you. And for that reason, the only goal that matters when it comes to your money is your own.
On this note, I wish you and your family a Very Happy Ganesh Chaturthi.