In his book Fooling Some of the People All of the Time, David Einhorn explains why he’s an absolute return investor, saying absolute return investors focus on the risk-reward trade-off of an investment, while relative return investors focus on outperforming a benchmark. Here’s an excerpt from the book:
We consider ourselves to be “ absolute – return ”investors and do not compare our results to long – only indices. That means that our goal is to try to achieve positive results over time regardless of the environment.
I believe the enormous attraction of hedge funds comes from their absolute – return orientation. Most long – only investors, including mutual funds, are relative – return investors; their goal is to outperform a benchmark, generally the S & P 500.
In assessing an investment opportunity, a relative – return investor asks, “ Will this investment outperform my benchmark? ”In contrast, an absolute – return investor asks, “ Does the reward of this investment outweigh the
risk? ”
This leads to a completely different analytical framework. As a result, both investors might look at the same situation and come to opposite investment conclusions.
The popular misperception is that investors are attracted to hedge funds for the status, the secrecy, the leverage, and, according to one preposterous magazine account, the high fees.
The truth is simpler: Asking the better question of risk – versus – reward gives hedge funds an enormous opportunity
to create superior risk – adjusted returns compared to relative – return strategies. While the media do not understand this, hedge fund investors do.
You can find a copy of the book here:
David Einhorn – Fooling Some of the People All of the Time
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