Absolute, trailing and rolling returns are three ways to evaluate a fund's performance. Read on to find out which return you should look at before investing in mutual funds to make the most out of your investment
As investors, most of us give high priority to historical returns when it comes to mutual funds investing. But did you know that there is more than one way in which you can measure returns?
Absolute, trailing and rolling returns are the three ways by which you can evaluate a fund's performance. Read on to find out which return you should look at before investing in mutual funds to make the most out of your investment.
This is the return that a fund achieves over a certain period of time. Under this method, an investor measures the percentage of appreciation or depreciation that a mutual fund achieves over a given period of time. It is the simplest return metric that is used to quantify how much profit or loss one has made from an investment.
For example, you invested in 100 units of fund X for NAV (Net Asset Value) Rs 10 and sold them after five years at NAV Rs 30. In this case, your absolute return would be 200 percent.
Why absolute returns are not the best parameter for investment | Absolute return does not provide a clear picture for mutual fund investment as it does not take into account the time period of investment and its compounding effect.
Furthermore, absolute numbers are generally high, which can give a false impression of mutual fund's worth compared to other assets. For example, a gain of Rs 60 lakh with an absolute return of 240 percent may seem impressive, but when we measure the same return in terms of compound annual growth rate (CAGR), it equates to a modest 8.17 percent.
These returns measure performance of a mutual fund for the past specific periods, such as one-year, three-year, five-year, 10-year or inception-to-date basis. In simple words, trailing returns is calculation of point-to-point returns and then annualising them.
This measure provides a more transparent picture compared to absolute returns as a mutual fund might have performed exceptionally well over a 10-year period, but might have had sedated growth in the last 2-3 years.
For example, let's say a fund started with a value of Rs 10 on January 1, 2010, ended with NAV of Rs 20 on January 1, 2014.
Then year-on-year return will be 18.92 percent [End Value/Start Value)^(1/Years)-1] compounding return till January 1, 2014.
This means that from January 1, 2010, to January 1, 2014, your investment has grown to Rs 11.89, result of [10+(10*18.92 percent)].
Next year i.e on January 1, 2012, return might be Rs 11.89 + 18.92 percent of 11.89 = Rs.14.14 and so on.
Why trailing returns are not the best parameter for investment | As the market fluctuates between highs and lows, the final trailing return can vary widely from one point to another.
The fund's performance near the end of the period and market trajectory may have undue influence on the entire trailing return. Also, a significant correction or fall in recent performance may make returns across all trailing periods appear healthy or weak.
This can give investors a distorted picture of the fund's performance and may provide an artificially superior or inferior profile.
These returns, also referred to as rolling period returns or rolling time periods, average out a series of returns over overlapping periods. It measures returns on mutual funds at different points of time, thereby eliminating any bias associated with returns observed at a particular point of time.
For instance, take a five-year rolling series starting April 1, 2005, for 15 years. Hence, returns would be calculated from April 1, 2005, to March 31, 2010; April 1, 2010 to March 31, 2015, and so on.
Through rolling returns, you can use several blocks of 3, 5 or 10-year periods at various intervals and see how a mutual fund performed over that period.
With rolling returns, one can look at various cycles to know the highest return, the lowest return and the average return of a fund for a specified period. These estimates allow investors to manage their expectations from the fund.
While rolling returns work on a probability basis, there is no bias towards any time period.
For example, if you bought a fund one year ago for Rs 100 and sold it today for Rs 110, your trailing return would be 10 percent. However, if the value of the fund drops to Rs 108 the following day, the trailing return would no longer be accurate for a one-year period.
Rolling return would take this fluctuation into account as it will consider returns between, let's say, January 1 to February 1, January 2 to February 2, January 3 to February 3 and take the average of these returns, thereby giving a more accurate result.Limitations of rolling returns | Rolling returns is a complex concept and there is no clear-cut formula to derive it.Not sure which mutual funds to buy? Download moneycontrol transact app to get personalised investment recommendations.