In our post, Did you know the basics of Mutual Fund investing, we explained some commonly used terms that investors come across, when investing in mutual funds. In this blog post, we will explain some common terms associated with one of the most important aspects of mutual fund investments. Why do we invest in mutual funds? The answer for almost all investors is fairly obvious; we want to get returns. If you go through different types of mutual fund literature like research websites, investment blogs, newspaper articles, factsheets, scheme information documents etc, you will come across different return terms. Let us understand what each of these terms mean.
Absolute return is the growth in your investment expressed in percentage terms. It can be understood with the help of a simple example. Suppose you invested Rs 1 Lakh in a mutual fund scheme. Three years later the value of your investment is Rs 1.4 Lakhs; you can know the value of your investment from the account statement sent to you by the AMC or the registrar (e.g. CAMS or Karvy). The total profit made by you is Rs 40,000. The absolute return earned by you in percentage terms is 40%. Absolute return ignores the time over which the growth was achieved; if your Rs 1 Lakh investment grew to Rs 1.4 Lakhs in 5 years (instead of 3), the absolute return will still be 40%.
Annualized return, as the name suggests, measures how much your investment grew in value on a yearly basis. An important thing to note in annualized returns is that, the effect of compounding is included. Compounding is, very simply, profits made on profits. If you invested Rs 1 Lakh in a mutual fund scheme and the value of your investment after 3 years is Rs 1.4 Lakhs, then annualized returns will be 11.9%. Notice that annualized return of 11.9% is less than the absolute return (40%) divided by the investment period (3 years); this is due to compounding effect. If you invested Rs 1 Lakh in a mutual fund scheme and the value of your investment after 5 years is Rs 1.4 Lakhs, then annualized returns will be 7%.
Total return is the actual rate of return earned from the investment and includes both capital gains and dividends. Let us assume that, you invested Rs 1 Lakh in a mutual fund scheme at a NAV of Rs 20. The number of units of the scheme purchased by you is 5,000 (1 Lakh divided by 20). The NAV of the scheme after 1 year is Rs 22. The value of your units after 1 year will, therefore, be Rs 1.1 Lakhs (22 X 5,000). The capital gains made by you will be Rs 10,000. Let us also assume that, during the year, the scheme declared Rs 2 per unit as dividend. Total dividend paid to you by the AMC would be Rs 10,000 (2 X 5,000). The total return earned by you will be Rs 10,000 capital gains + Rs 10,000 dividends = Rs 20,000. The total return in percentage terms will be 20%.
Trailing return is the annualized return over a certain trailing period ending today. Let us understand this with the help of an example. Suppose the NAV of a scheme today (March 10, 2017) is Rs 100. 3 years back (i.e. March 10, 2014), the NAV of the scheme was Rs 60. The 3 year trailing return of the fund is 18.6%. Suppose the NAV of the scheme 5 years back (i.e. March 10, 2012) was Rs 50. The 5 year trailing return of the fund is 14.9%.
The formula for trailing return (in excel) is as follows:-
The trailing period can be 1 year, 2 years, 3 years, 5 years, 10 years etc; basically any period. Trailing return is the most popular mutual performance measure. The returns that you see on most mutual fund websites are actually trailing returns. If you go to our Mutual Fund Research section, Top Performing Funds, the returns that you see are, in fact, trailing returns. Investors should note that, trailing returns are biased by current market conditions relative to market conditions prevailing at the start of the trailing period. Trailing returns are high in bull markets and low in bear markets.
As the name suggests, point to point returns measures annualized returns between two points of time. For example, if you are interested in how a mutual fund scheme performed during a particular period, say 2012 to 2014, you will look at point to point returns. To calculate point to point returns of a mutual fund scheme, you necessarily need to have a start date and end date. You will look up the NAVs of the scheme on start and end dates, and then calculate the annualized returns. In our Mutual Fund Research section, you find point to point returns of one or more schemes by using our Mutual Fund Point to Point Returns - Multiple Schemes & Periods tool.
Annual return of a mutual fund scheme is the return given by the scheme from January 1 (or the earliest business day of the year) to December 31 (last business day of the year) of any calendar year. For example, if the NAVs of a scheme on January 1 and December 31 are Rs 100 and 110 respectively, the annual return for that year will be 10%. Most mutual fund research portals, including our portal, show annual returns of a scheme in the scheme details page. Annual returns are shown on the scheme details page in moneycontrol.com and advisorkhoj.com. In valueresearchonline.com and Morningstar.in, you will find annual returns in the performance tabs within the scheme details page. Mutual funds are market linked investments and the market conditions in a particular year will have a significant impact on annual returns. However, comparing annual returns across years relative to benchmark or fund category, can give you a sense of fund performance consistency.
Rolling returns are the annualized returns of the scheme taken for a specified period (rolling returns period) on every day/week/month and taken till the last day of the duration compared to the scheme benchmark (e.g. Nifty, BSE – 100, BSE – 200, BSE – 500, CNX – 500, BSE – Midcap, CNX – Midcap etc) or fund category (e.g. large cap funds, diversified equity funds, midcap funds, balanced funds etc). Rolling returns are usually shown in a chart format. A rolling returns chart shows the annualized returns of the scheme over the rolling returns period on every day from the start date, comparedto the benchmark or category.
Rolling returns is not widely used in India, but is widely accepted globally as the best measure of a fund's performance. Trailing returns have a recency bias (as explained earlier) and point to point returns are specific to the period in consideration (and therefore, may not be relevant for the present time). Rolling returns, on the other hand, measures the fund's absolute and relative performance across all timescales, without any bias. Rolling return is also the best tool to understand, performance consistency and the fund manager’s performance.
We, in Advisorkhoj, are proud that, we are among the very few mutual fund research portals which show rolling returns. You can see rolling returns of any mutual fund scheme relative to the benchmark, by using our tool Rolling Return vs Benchmark. You can see rolling returns of one or more mutual fund schemes relative to their fund category, by using our tool Rolling Return vs Category. In advisorkhoj.com, in addition to the chart format, we also show rolling returns in a tabular format. To see rolling returns in tabular format on our portal, you can click on the button, See Rolling Returns in Tabular Format, on the bottom right hand side in rolling return pages.
Which is more important, absolute return or relative return? It differs from individual to individual and we can debate this till the cows come home, but the reality is that, in this competitive age, there is emphasis on relative performance, both in our work-place and also for our kids in school. Quartile ranking is a measure of relative performance of mutual fund scheme. Investors should note that, quartile ranking is not a measure of returns, but is actually a rank versus against all other funds in its category.
The rankings range from "Top Quartile" to "Bottom Quartile" for different time periods. Mutual funds with the highest percent returns in the chosen time period are assigned to "Top Quartile", whereas those with the lowest returns are assigned to "Bottom Quartile". Quartile rankings are compiled by sorting the funds based on trailing returns over a period chosen by the user. Funds in the top 25% are assigned the ranking of "Top Quartile", the next 25% are assigned a ranking of "Upper Middle Quartile", the next 25% after that are assigned a ranking of "Lower Middle Quartile" and the lowest 25% are assigned the ranking of "Bottom Quartile". While, the current quartile ranking of a mutual fund scheme is important, even more important is the consistency of quartile ranking across several quarters. You can see quartile ranks of different mutual fund schemes in a category in our research tool, Mutual Fund Quartile Ranking.
All the returns measures that we have discussed thus far, relate to lump sum or one-time investments. Lump sum investment returns are relatively simpler to measure because, essentially you are measuring growth in investment value between two points of time (in the case of total returns, dividends, if any, also need to be factored). However, systematic investment plan (SIP) represents a series of cash-flows and so computing SIP returns is more complicated. The financial metric used to calculate the returns from a series of cash-flows (e.g. SIP, SWP, STP etc) is known as the Internal Rate of Return (IRR). The formula of IRR is outside the scope of this post. If cash-flows are not an exact regular time intervals, then a modification of IRR, known as XIRR (in excel), is used to measure SIP returns.
You can see XIRR of SIPs of different mutual fund schemes across different time periods in our Mutual Fund Research section, Top Performing Systematic Investment Plan. If you want to see SIP returns over a specific time period, you can use our tool, Mutual Fund SIP Calculator. Some AMCs offer SIP products where you can increase the SIP installments on an annual basis; these products are known as Step up SIP, SIP Top up etc.
You can see SIP returns with annual increase in installment amounts using our tool, SIP with Annual Increase. In addition to SIP returns, you can also see Systematic Transfer Plan (STP) returns (using our tool, Mutual Fund STP Calculator) and Systematic Withdrawal Plan (SWP) returns (using our tool, Mutual Fund SWP Calculator). The returns calculation methodology of SIP, STP and SWP are similar; just the cash-flow profiles are different.
In this blog post, we have tried to explain, different terms associated with mutual fund returns. Equipped with a superior understanding of different types of returns, hopefully, you will be to make better use of mutual fund research available on different portals / blogs. You should also be able to evaluate the performance of mutual fund schemes in your portfolio more effectively. In the next part of this series, we will try understand some more terms, commonly found in factsheets and research portals regarding fund portfolios. Please stay tuned for more.......
Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.
An alumnus of IIM Ahmedabad, Dwaipayan is a Finance and Consulting professional, with 13 years of management experience, mostly in MNCs like American Express and Ameriprise Financial, both in India and the US. In his last role, he was the Chief Financial Officer of American Express Global Business Services in India. His key interests are building best in class organizations, corporate governance and talent development
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