Absolute-return Strategy

Most funds want to beat the market. An absolute-return strategy wants something different. It wants to make money no matter which way the market moves.

So it cannot just hold stocks and wait for the index to rise. Instead, these Category III AIFs use leveraged positions, concentrated positions, long/short positions or market-neutral positions. They trade equity derivatives, commodity derivatives, index derivatives and other tools that do not depend on a rising market.

The strategy is built to ignore the market. So it makes no sense to judge it against a market index. And it is not judged that way.

Instead of a broad-based index like the NIFTY 50, an absolute-return strategy is benchmarked against a fixed rate, set by the Investment Manager when the scheme is launched — the workbook gives 10% per annum as an illustrative figure. Returns are computed at year-end, or over shorter intervals such as monthly or quarterly, and compared to that fixed rate: beat it, and the fund has over-performed for the period; fall short, and it has under-performed — regardless of what any market index did over the same period.

This is a genuinely different idea from a plain "absolute return", which is just the rupee gain or loss on an investment relative to what was invested. It is also distinct from the specific mechanics of the absolute-return benchmark itself — the fixed-rate number and the GIPS-style criteria for what makes any benchmark valid. This page is about the strategy that needs that kind of benchmark in the first place: one built to be independent of the market, not the number it is measured against.

Godavari Absolute Return Fund, a Category III AIF, sets a fixed benchmark of 10% per annum at launch and runs a market-neutral strategy — taking equal long and short positions so that broad market moves largely cancel out.

In Year 2, the fund still made money while the broader market fell sharply — a result that would look spectacular against a market index. But because the fund is judged against its own fixed 10% benchmark, Year 2 is recorded as under-performance. That is the trade an investor in an absolute-return strategy knowingly accepts: returns that do not track the market, judged against a number instead of an index.

Chapter 6, section 6.3 (Performance Benchmarking), introduces the absolute-return strategy directly after explaining why some Category III AIFs cannot be benchmarked to a broad-based market index, and gives the fixed-rate benchmarking approach with the 10% illustrative figure. Expect a question on why an absolute-return strategy uses a fixed-rate benchmark instead of an index, and one distinguishing the strategy from the plain "absolute return" return-calculation concept.

• "Absolute-return strategy" is a fund strategy; "absolute return" is a return calculation. The exam can test either meaning of "absolute" — read the question carefully.
• The benchmark is a fixed rate set at launch, not zero and not a market index. A fund can beat the market and still "under-perform" its own fixed benchmark, and vice versa.
• Absolute-return strategies commonly use leverage and derivatives — they are not simply "cash-like" or low-risk because they avoid tracking the market.
• Reporting intervals can be shorter than annual — monthly or quarterly — which affects how often over- or under-performance is assessed.