Friday, Nov 8 2024
Source/Contribution by : NJ Publications
As investors, we are very cautious about the value of our hard-earned money. So, we meticulously evaluate the performance of mutual funds using various metrics before making investment decisions. One of the most common methods used by mutual fund investors to evaluate performance is historical returns.
While there are several ways to calculate historical returns of an investment, two of the most common metrics are Point to Point Returns and Rolling Returns. Without a clear understanding of what these returns reveal about an investment product, it can be difficult to select the best investment options.
In this article, we will explain each method, outline their differences, and provide guidance on how to interpret these returns to optimize your investment choices.
Point to Point Returns:
Point-to-Point Returns, measure the return of an investment from a specific starting point to an ending point. It shows performance at a particular point in time and not performance over a period of time. It is simple and easy to calculate.
Example:
| 1 Year Point to Point Return | 5 Years Point to Point Return | ||
| Date | NAV | Date | NAV |
| 31/03/2023 | 100 | 31/03/2019 | 64 |
| 31/03/2024 | 117 | 31/03/2024 | 117 |
| CAGR - 17% | CAGR - 12.82% | ||
Limitations:
Drawing conclusions from looking merely at these returns would be misleading as the representation does not show a true picture of events. For example, if two funds have similar returns, you cannot find which one is the more volatile fund. Let’s understand with an illustration.
Suppose, both Fund A and Fund B have delivered a 10% absolute return over the past 5 years. This snapshot looks great for both! Point to point returns don't show us the journey within those 5 years. Maybe Fund A had a steady, consistent 10% growth year-over-year for the past 5 years. While Fund B had a Fantastic first year with a 50% return, followed by 4 years of flat or even slightly negative returns, averaging out to 10% over 5 years. Here, Fund B could be a riskier option with a higher chance of volatility. But only looking at the 10% point to point return would never give you any idea about the volatility in both the fund’s past performance. Trailing returns wouldn't tell us the difference between these two scenarios. They only show the end result, not the path taken to get there.
- The point to point return of funds can paint a very different picture of performance. They are influenced either by what happened on the start date or on the end date. A scheme might have underperformed throughout the period, however if the scheme out performs in the last few days, the overall performance might improve and vice versa.
For instance, let's assume that an investment in a mutual fund scheme was made 3 years ago. Between then and now, the scheme NAV has more than doubled. But for the first two years, it generated lackluster returns compared to peer funds. The scheme outperformed in the last one year. Computing the 1 year point-to-point return would show a bright picture which would be misleading.
The way to avoid being influenced in this manner is to look at returns over a longer period. Therefore, rolling returns must be referred to take into account market cycles and present a more realistic picture.
Rolling Returns:
Rolling returns are the annualized average returns for a period such as 1 year, 3 years, 5 years, etc. calculated at regular intervals. In other words, a rolling return takes the average of all return points for the chosen period.
For instance, a 3-year rolling return would calculate the annualized return for every three-year period within the overall investment time frame.
Rolling returns can be calculated daily, weekly, monthly or yearly.
Example:
Suppose we want to see a 5-year rolling return of a fund over the period of 15 years between 31 July 2009 to 31 July 2024. So, calculate the 5-year return on each day during this period i.e. the 5-year return as on 31st July 2009, 1st August 2009, and so on till 31st July 2024. It will show you a spread of returns had you invested on any day during this period.
| Period: 31st July 2009 - 31st July 2024 (Five Year daily Rolling) | |||||
| Observations | From Date | NAV | To Date | NAV | Ann. Returns |
| First Two Observations | 31-Jul-2009 | 95 | 31-Jul-2014 | 154.6 | 10.23 |
| 1-Aug-2009 | 96 | 1-Aug-2014 | 161.77 | 11.00 | |
| Last Two Observations | 30-Jul-2019 | 316 | 30-Jul-2024 | 707.74 | 17.5 |
| 31-Jul-2019 | 317 | 31-Jul-2024 | 695.01 | 17 | |
| AVERAGE ROLLING RETURNS (3654) OBSERVATIONS | 13.93 | ||||
With a higher number of observations, Rolling returns provide a more comprehensive view of the fund's performance across different market conditions. It helps in identifying the fund's consistency and ability to weather various market cycles.
One of the limitations of rolling return is that it is more complex to calculate and understand compared to point-to-point returns.
Conclusion
Both point-to-point returns and rolling returns provide valuable insights into investment performance, each serving a different purpose. Point-to-point returns offer a straightforward view of performance between two specific dates, ideal for short-term evaluations and comparisons. In contrast, rolling returns deliver a more comprehensive perspective, capturing performance consistency and variability over overlapping periods, making it useful for long-term assessments.
Investors should consider both metrics to gain a fuller understanding of their investments and make more informed decisions. By leveraging these performance measures, you can better evaluate your investment’s historical performance and its potential for future returns.
NOTE:
Both rolling returns and point-to-point returns rely on historical data. Past performance is not indicative of future results. While these metrics offer valuable insights, they should be used in conjunction with other factors like the fund's investment objective, portfolio composition, and expense ratio when making investment decisions.
