How do you shortlist funds for your clients? Performance, for one, is an important indicator. Investing in a scheme involves trusting the expertise of the fund manager. And historical performance is an indicator of the fund manager's capabilities. Analysing past performance therefore gives a fair idea whether the scheme is right for your clients.
Generally, we review a scheme’s 1-year, 3-year, 5-year and 10-year returns to evaluate performance. However, these returns do not accurately capture the actual returns of the fund. This is because the scheme’s NAV changes daily and your clients can enter and exit the fund on any date. Moreover, their holding period can be of 6 years or any other arbitrary time-frame. Thus, in isolation point-to-point returns do not give the complete picture.
Additionally, looking at returns at a certain point in time can be misleading. Let us consider looking at 10-year returns of an equity scheme today. There is high probability that the scheme would have given modest returns owing to Sensex being at high levels in 2008. Fast forward one year assuming the equity market rally continues and you again calculate 10-year returns. Then it is a safe bet that the scheme would have delivered fantastic returns owing to equity market crash in 2009.
Thus looking at 10-year returns in isolation may turn an investor away from equities today and lure him/her to equities one year down the line. Thus, point-to-point performance gives no clue about a scheme’s return consistency. As equities are a volatile asset class, they have delivered bumper returns in some periods and abysmal returns in others. Thus, understanding a scheme’s performance over a long period will help you make a more informed recommendation. Moreover, reviewing fund performance in different market conditions will help you understand if the fund manager has been able to outperform markets during both rally and downturn.
Hence, reviewing a scheme’s rolling returns is imperative to understand a fund’s potential and the fund manager’s skill.
What are rolling returns?
Rolling returns mean calculating the return for a particular period (e.g. 1 week, 1 year…) at pre-defined frequency over a period of time.
Rolling returns nomenclature
Weekly rolling 1 year returns over 3 years.
Let us now unpack this:
Weekly rolling – Here weekly rolling refers to the frequency of return calculation
1-year returns – Denotes that you need to calculate 1-year CAGR returns
Over 3 years – Means the period during which returns will be calculated
For e.g. consider you want to review a scheme. You decide to look at its 1-year return (as on 31/12/2001), which is 15%. However, not being satisfied you decide to check its quarterly rolling 1-year returns over a 2-year period. Assume the period is 31/12/1999 to 31/12/2001. Let us see the difference between rolling returns and trailing returns:
|
Date |
1-year return |
|
31/12/1999 |
12% |
|
31/3/2000 |
10% |
|
30/6/2000 |
5% |
|
30/9/2000 |
7% |
|
31/12/2000 |
10% |
|
31/3/2001 |
12% |
|
30/6/2001 |
17% |
|
30/9/2001 |
13% |
|
31/12/2001 |
15% |
|
Average returns |
11% |
As you can see, though scheme’s 1-year return as on date is 15% the rolling returns are much lower at 11%. Thus looking at rolling returns, you can gauge what returns to expect from the scheme considering your client’s investment horizon.
Additionally, rolling returns are derived from multiple data points instead of a single data point that is trailing return. Thus, it is a more statistically vigorous parameter for performance evaluation.
Why look at rolling returns and trailing returns together?
- Trailing returns may not give an accurate picture
Generally, point-to-point returns are calculated on month-ends or quarter-ends. However, there may be a variance in scheme performance in the interim. Thus to truly appreciate the fund’s performance you need to see rolling returns along with trailing returns.
- Prevents you from being influenced by the latest data
A scheme may have delivered blockbuster returns in the last 1 year, but if we look at its 5-year history, the performance is erratic. Then if we look at trailing returns in isolation, it may seem to be a good investment option. However, analysing rolling return data may reveal that the fund has volatile performance and you need to be careful while recommending it to clients.
