absolute vs relative return: which is harder?
as the title suggests, which one would you say is harder? I know the question to some might obvious (relative return is easier) but to me, not so much. here's what I think:
1) skill involved in absolute return strategies massively differentiates wheter we are in a bull/bear market so if you happen to find in a down phase (generally triggered by macro stuff) getting a positive return might imply enormous ability but
2) skill in the relative space implies you perform better than the benchmark of reference (which is usually, in the case of equities, a national / sovranational equity index) which means that you have to know fully well each and every sector under the sun and might have to stay involved in stories which scream "ultra expensive" from a mile away and over which you have no control (case in point - Amazon - or something similar) and, to add insult to the injury, you might have to pit it against a not so correlated sector (i.e.: transportation).
as I see it, it's like deciding wheter it's harder to get good results in a bear market with the promise of an absolute positive return in bets of your choice (meaning you don't necesseceraily have to know what happens in each sector) against the skill to know how each and every sector will perform against one another which frankly, from my point of view, is difficult beyond belief.
I realize the metrics of "success" for the different strategies are different since in one case you are paid to have a result (+2%? +5%? +10%? with which level of volatility) and in the other one you want a risk adjusted return on a smaller scale so relating the two is harder (is a +5% Abs Ret fund better than a +2% on bench mutual fund? ) but still, to me there is no clear winner.
what do you think?
In my opinion, all that matters is return per unit of risk. The rest is just bullshit, excuses and marketing.
2 different deals imho (that in reality the two don't differ massively is another story). I mean I am looking at facebook and if I am a MF PM I might think: "will it outperform its peers in the tech sector? will it outperform the index (made of a bunch of other sectors I may know very little about)? stocks may fall but if facebook falls a bit less, I am a winner (all else equal). period. whereas if I am a HF PM I would ask: is facebook a solid buy now on an absolute basis? in the same event described before, I am screwed (for the lack of a more offensive term).
what if you have a leveraged/hyped growth story? in one case you have to ride it to a certain degree but in the other case you may pass.
With relative returns, you have more bullets to use - you could be just underweight a sector and overweight another that has persisted. For example, the S&P healthcare sector has done 15.7% annualized over the past 5 years versus 7.7% for the broad S&P (I just googled the numbers so apologies for wrong info). I know I'm cherry picking, but something as simple as a sector overweight could outperform the benchmark, and you don't necessarily 'need to know' everything that goes on in every sector to do that. In addition to this, you can have a quality bias, buy low P/E stocks, etc. AND have stock selection to get superior returns relative to a benchmark. As long as you can get it right more than 50% of the time, you'll beat benchmark, theoretically.
On the absolute side, if you remove the beta to do a long/short strategy or a portable alpha strategy, that means that you need to pick stocks that have catalysts of some sort to make money - events, M&A, post earnings beat, etc. which means that you have to rely mostly on stock selection (theoretically). So you could argue that finding catalysts is a lot of work (just look at one of Bill Ackman's presentations and think about the poor soul who had to make all 300 pages of the presentation) and doesn't necessarily pay off as easily as something like a sector overweight, and you have to be right on many of these ideas.
So if I'm interpreting your question right my answer is absolute returns are more work and if you define work as harder, then absolute... but if you're asking about how hard it is for both strategies to make money, it's just plain hard to do right and well consistently. I would also agree with others who have said that value to an absolute return investor versus value to a long only benchmark aware manager are two very different things and you can't compare a long only manager's alpha to a long/short manager's absolute return as apples to apples - the risks, incentives, objectives and a myriad of other things are different.
the main answer I was asking myself was: given that if I am L/S on a bad time I can't do absolute, is it better to be a mutual fund manager who can experience shaky footing both on good and bad times as he always need to be better than a benchmark of reference?
If the market is up, relative returns are harder. If the market is down, absolute returns are harder.
To the guy above who says all that matters is return per unit of risk is the only thing that matters: Plenty of guys owning only Internet stocks had a Sharpe ratio north of 1 ending in 1999. Many of those same people were down 90%+ in the next few years. So, if you looked at the Sharpe and invested with them, you lost almost everything if you weren't minding the risk inherent in that type of strategy that produced pretty good risk adjusted returns on an absolute basis.
Ultimately, the question is just mental masturbation. It's kind of fun, but it won't produce anything of value.
95% of these forums are masturbation of some kind!
You're right - I made too much of a blanket statement. Obviously, sharpe ratios have their pitfalls. For instance, depending on the strategy, a high sharpe ratio could simply indicate a long period of very consistent, small gains. However, these strategies could be vulnerable to black-swan events, which eventually wipe it out. In addition, strategies that have long holding periods are also very vulnerable to getting wiped out. In these cases, sharpe ratio is pretty useless. I guess my mind was focused on short-term quant trading when I wrote that post, haha.
Out of curiosity, which funds are you referring to? Fundamental or quant funds? LTCM?
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