Relative return measures the performance of an investment compared to a benchmark or reference index, indicating how well it has done in relation to the market or a specific standard.
Relative return is a financial metric used to assess an investment's performance by comparing its returns against a benchmark such as a market index, peer group, or a predefined standard. Unlike absolute return, which reflects the raw gain or loss on an investment over a period, relative return expresses the excess or shortfall an investment has generated compared to its benchmark. It is often expressed in percentage points and can be positive, indicating outperformance, or negative, indicating underperformance. In wealth management and family office settings, relative return is a critical tool for performance evaluation and manager assessment. By benchmarking portfolio returns to appropriate indices or customized composites, advisors can contextualize results and understand the value added or lost through active management decisions. Relative return thus serves as a foundation for performance attribution, risk assessment, and strategic adjustments within an investment portfolio.
Measuring relative return is vital in investment strategy because it helps determine whether a portfolio's performance justifies its risk profile and management fees. It allows wealth advisors and family office professionals to evaluate active managers against passive benchmarks, aiding decision-making about manager retention or mandate changes. Furthermore, relative return analysis supports transparent reporting to stakeholders by contextualizing gains or losses against market movements. From a tax planning and governance perspective, understanding relative return can assist in identifying areas where tax-efficient strategies or risk controls might enhance net performance. It also fosters accountability by setting performance expectations relative to market standards, promoting prudent investment management aligned with family office objectives.
Consider a family office portfolio that has returned 12% over one year. The S&P 500 index, used as the benchmark, returned 10% for the same period. The relative return of the portfolio is 12% - 10% = +2%, indicating that the portfolio outperformed the benchmark by 2 percentage points.
Absolute Return
Absolute return refers to the total return that an investment achieves over a period without comparing it to any benchmark. It focuses on the raw gain or loss irrespective of market conditions, unlike relative return which benchmarks performance against a standard.
What is the difference between relative return and absolute return?
Relative return measures an investment's performance compared to a benchmark, showing whether it outperformed or underperformed a reference standard. Absolute return measures the actual gain or loss of an investment over time without comparison to any benchmark.
Why is relative return important for evaluating portfolio managers?
Relative return helps assess how well a portfolio manager performs against a benchmark or peers, providing insight into their value-add through active management decisions. It is essential for evaluating the effectiveness and justification of management fees.
Can a positive absolute return coincide with a negative relative return?
Yes, an investment can achieve a positive absolute return but still underperform its benchmark, resulting in a negative relative return. For example, if a portfolio returns 5% but the benchmark returns 8%, the relative return is -3%.
