Evaluating Fund Performance

In Financial Tools, Mutual Funds by Mitul Daga5 Comments

Assessing a mutual fund’s past performance and speculating its future performance can be delusive unless we have the appropriate mechanism to do so. Contrary to the popular belief of using trailing return as a mode of fund assessment, Rolling Return is a far more effective mechanism to evaluate a fund.

Rolling return is the annualized average return for the selected period beginning at a given start date and advancing one day (rolling frequency) sequentially till the last available date. This method provides a more accurate and in-depth picture of a portfolio’s performance as return is calculated every day for the period under observation rather than being dependant on any specific time frame.

For example, if we want to look at returns of an equity mutual fund in the last one year, instead of just looking at returns from say 31 December 2016 to 31 December 2017 we can look at one year returns on every day of the last year. The returns would be calculated from 31 December 2016 to 31 December 2017, from 30 December 2016 to 30 December 2017 and so on till one year returns from 31 December 2015 to 31 December 2016 and the average of all these would be calculated to compute the 1 year rolling return. Thus, the rolling return will give us a better sense of a fund’s performance over the year rather than just looking at the trailing return from one point to another.

Key Benefits of Rolling Return

  • Monitors consistency of returns:
  • As rolling returns are calculated daily for the period under observation, we get an idea as to how the fund has performed on an average which is much more informative than the trailing return which is solely dependent on the most recent period. We can also see the distribution of returns, which helps us in identifying funds which are more consistent as compared to others.

  • Alternative to the point-to-point or trailing return:
  • Point to point or trailing return only show the percentage change in return between two specific dates but there are variations in between and the assessment may be misleading and may not hold true for investments made on any other date. Irrespective of any specific date, rolling return exhibits the composite performance for a time period and hence, is a much better approximation of fund performance.

  • Highlights the range of a fund’s high and low periods of performance:
  • By the virtue of the comprehensive return history, rolling return can comprehend the high and low periods of performance in the entire gamut of time. For instance, if a fund has been rolled daily over 10 years with a 5 year rolling return, we will be able to determine the best 5 year performance period from the worst within the 10 year time frame at a daily frequency.

Fund Selection – Rolling Return v/s Trailing Return

Consider the following table which illustrates the difference in returns between rolling return and trailing return:

Fund Name 3 Yrs Trailing Return (%) 3 Yrs Rolling Return (%)
Fund A 13.02 18.99
Fund B 13.81 20.80
Fund C 16.08 17.01
Fund D 11.98 19.36
Fund E 12.90 20.39
Fund F 11.90 18.30
Fund G 13.21 19.77
Fund H 13.45 18.85
Fund I 12.28 20.19
Fund J 12.70 16.77

Note: Actual fund performance but names changed for illustration purpose

Suppose, we want to select 2 funds from a universe of 10 funds on the basis of 3 year historical annualised return.

One would select Funds B and C on the basis of 3 year trailing return. However, rolling return throws up Funds B and E as the most consistent performers over the last 3 years. So, one can easily conclude that Fund C has performed well over the most recent 3 year period but its performance is not as consistent when compared to Fund E. Thus, Funds B and E should be the preferred choice of investors looking for top performing funds along with consistency.

As seen above, rolling return helps investors in choosing the most consistent performers over a time period. However, an important point to keep in mind is that better rolling return does not guarantee better fund performance going forward. But, it definitely increases the probability of outperformance due to consistent track record.

Now, you can easily access the rolling return of all the mutual funds over various time frames and easily compare upto 5 funds at a time to pick the most consistent ones by exploring this tool Mutual Funds Rolling Return.

Happy investing!

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  1. Would it merit if one also calculates the standard deviation along with the mean of rolling returns, thus giving sense to variability.

    1. Low volatility as measured by standard deviation has been of little predictive value. Rather, most of the top performing equity funds are usually more volatile than their category averages. However, it would be a good metric to look at when selecting debt funds.

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