What are the different types of returns in mutual funds

                 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:

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:

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:

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:

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:-

= (Today’s NAV / NAV at the start of the trailing period) ^ (1/Trailing Period) – 1

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.

Point to Point Returns:

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.

Annual Return:

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:

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, compared to 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.

Quartile Ranking:

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.

SIP Returns / XIRR:

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 cashflows are not an exact regular time intervals, then a modification of IRR, known as XIRR (in excel), is used to measure SIP returns.