Relative return objective
Also written Relative return target · Benchmark-relative objective
A return objective stated against a benchmark rather than as a standalone number — for example, to earn 5% a year more than the Nifty 50 for the next several years.
In plain language
An investor has to say what return she wants. There are two ways to say it.
One is a plain number: earn 15% a year. That is an absolute return objective — a standalone figure, compared with nothing.
The other is stated against a yardstick: earn 5% a year more than the Nifty 50. That is a relative return objective.
The difference is not cosmetic. It changes what counts as success. If the Nifty falls 20% and the portfolio falls 16%, the relative objective has been met and the absolute one has failed badly.
It also changes how the portfolio is run. A relative objective ties the manager to the benchmark — she has to hold enough of it to track it, and take enough bets away from it to beat it.
Both kinds of objective are set in relation to risk, return and liquidity together.
How it works
The workbook's framing (Chapter 9, section 9.3.4). Investors' objectives are identified in relation to risk, return and liquidity. Investors may state their investment objectives in terms of a desired return in an absolute or a relative sense. The desired absolute return is the return of the investment measured on a standalone basis without any comparison with any other asset — the workbook's example being to generate 15% p.a. on her investment for the next n number of years. The same objective can also be expressed as to generate 5% p.a. more than the return on NIFTY 50 each year on the investment for the next n number of years.
So the two figures the workbook gives are a 15% p.a. absolute objective and a 5% p.a. over the NIFTY 50 relative one, each over n years.
The relationships the objective has to respect. Risk and return typically have a positive relationship — higher risk, higher associated return. Liquidity has an inverse relationship with return when return is expressed as a discount rate: the more liquid an asset, the lower the discount, because the gap between the quoted selling price and the actually realised price is minimal.
Why a relative objective needs a stated period. The workbook's own wording attaches each year, for the next n number of years to the relative objective. A benchmark-relative target without a horizon cannot be assessed, because a single year's outperformance says nothing.
What objectives lead to. The workbook's chain runs: generally investors invest for preservation of capital, regular income and capital appreciation — and tax saving, though it notes tax saving is not appreciated as the sole motive. The investment objectives then lead to the asset allocation decision. Capital appreciation calls for high-return investments such as equity, with higher risk than government securities or bank deposits. Capital preservation tilts the allocation towards safe bonds and debt securities. A regular income objective calls for asset classes that generate periodical income — dividend-paying stocks, interest-paying bonds, rent-paying realty.
Section 9.3.5 then deals with the constraints — liquidity needs, time horizon and unique needs — that limit which of those exposures can actually be taken.
A worked example
Illustrative figures built on the workbook's own formulation. Two clients of the same PMS, each investing Rs 1,00,00,000 for five years.
Mr Raval — absolute objective. Generate 15% p.a. At 15% compounded, Rs 1 crore becomes about Rs 2,01,00,000 in five years.
Mrs Nadkarni — relative objective. Generate 5% p.a. more than the NIFTY 50, each year.
Now see how the same market treats them.
| Year | Nifty 50 | Mrs Nadkarni's target | Portfolio delivered | Absolute verdict | Relative verdict |
|---|---|---|---|---|---|
| 1 | +18% | +23% | +24% | Pass | Pass |
| 2 | −22% | −17% | −15% | Fail | Pass |
| 3 | +9% | +14% | +11% | Fail | Fail |
| 4 | +26% | +31% | +33% | Pass | Pass |
| 5 | +4% | +9% | +12% | Fail | Pass |
In year 2 the portfolio lost Rs 15,00,000 of a Rs 1 crore base and still met the relative objective, because the index lost 22%. Mr Raval's objective is simply missed — a 15% target does not bend for a bad market.
In year 3 the portfolio made Rs 11,00,000 and failed the relative objective, because beating the index by 5 points required 14%.
Neither objective is better. They answer different questions. Mrs Nadkarni is asking her manager for skill against the market; Mr Raval is asking for a rupee outcome he can plan around, and no index will deliver that to order.
Why NISM asks about it
Chapter 9 (Portfolio Management Process), section 9.3.4 (Investment Objectives), gives the absolute-versus-relative distinction with the 15% p.a. and 5% p.a. over the NIFTY 50 examples, the risk-return-liquidity relationships, and the chain from objective to asset allocation.
Expect a question asking which kind of objective a stated sentence is — the giveaway is whether a benchmark is named — and one on the relationship between liquidity and return (inverse, when return is a discount rate). The three common motives for investing, and the caution that tax saving should not be the sole motive, are also examinable from the same section.
Common exam traps
- A relative objective names a benchmark; an absolute one names only a number. That is the whole test, and it is how a question is set.
- A relative objective can be met in a losing year. Beating a falling index still counts. Candidates mark this wrong because the portfolio lost money.
- Both objectives need a time period. The workbook attaches for the next n number of years to both formulations.
- Liquidity has an inverse relationship with return when return is expressed as a discount rate — the more liquid the asset, the lower the discount. Risk and return, by contrast, move together.
- Objectives drive asset allocation, not the other way round. Capital appreciation points to equity, capital preservation to safe debt, regular income to dividend, interest and rent-paying assets.
- Do not confuse the objective with the constraints. Objectives say what is wanted; constraints — liquidity needs, time horizon, unique needs — say what is possible.
Where this is taught
Free preparation for NISM Series XXI-BRelated terms
- Asset allocationThe decision on how to distribute a client's wealth across asset classes — the first decision in building a portfolio, and the one that explains most of what the portfolio then does.
- BenchmarkThe independently published index a scheme's performance is measured against, chosen to match its investment objective, asset allocation and strategy, and disclosed in the Scheme Information Document.
- Information RatioActive return over the benchmark divided by tracking error — how much outperformance a manager delivers for each unit of risk taken by deviating from the index.
- Tracking errorThe gap between the return of a passive fund and the return of the index it is trying to replicate — the measure of how faithfully an index fund or ETF does its one job.
- Investment constraintsLimits on the investments an investor can take exposure to — liquidity needs, time horizon, regulatory and tax constraints, exposure limits, and unique needs and preferences — recorded in the IPS.
- Investment ObjectivesAn investor's goals expressed in terms of risk, return and liquidity preferences — such as capital preservation, capital appreciation, current income or tax saving.
- Absolute return objectiveA return goal stated on its own, such as 15% a year, with no comparison to a benchmark — the opposite of a relative return objective.