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Performance Measurement Tools – Rolling Returns

Introduction

If you open any mutual fund app, you usually see "1 Year Return: 15%" or "5 Year Return: 12%". These are Point-to-Point Returns (from Start Date to End Date). While simple, they are often misleading. To truly judge a fund's quality, smart investors and analysts use a more advanced tool called Rolling Returns.

1. The Problem with Point-to-Point Returns

Scenario:

  • Fund A: 5 Years ago (2018), NAV was ₹10. Today (2023), NAV is ₹20.
  • Return: 100% Absolute (or ~14.8% CAGR).

The Trap: What if the fund did NOTHING for 4 years (NAV stayed ₹10) and suddenly jumped to ₹20 only in the last month?

  • The "5 Year Return" looks great (14.8%), but the investor suffered for 4 years.
  • Point-to-Point returns depend entirely on the Start Date and End Date. If the End Date is during a market crash, the returns look terrible. If it's a market peak, they look amazing.

2. The Solution: Rolling Returns

Definition: Rolling Returns measure the fund's performance over every possible period of a specific duration (e.g., 3 years) throughout its history.

How it works (Example: 3-Year Rolling Return):

  • Window 1: Return from Jan 1, 2010 to Jan 1, 2013.
  • Window 2: Return from Jan 2, 2010 to Jan 2, 2013.
  • Window 3: Return from Jan 3, 2010 to Jan 3, 2013.
  • ...calculated daily for 10 years.

Result: You get thousands of data points. You then calculate the Average Rolling Return.

  • This tells you: "If an investor entered this fund on any random day and held for 3 years, what return did they usually get?"

3. Why Rolling Returns are Better?

  1. Eliminates Timing Bias: Since it covers every single day, it removes the luck factor of entering at a bottom or exiting at a top.
  2. Measures Consistency:
    • Fund X: Average Rolling Return 12%. Negative periods: 5%.
    • Fund Y: Average Rolling Return 12%. Negative periods: 25%.
    • Verdict: Fund X is better because it rarely loses money, whereas Fund Y is volatile (risky) even if the average is same.

4. Other Performance Measures

A. CAGR (Compounded Annual Growth Rate)

  • Smoothens the volatility.
  • Formula: (End Value / Start Value)^(1/Years) - 1.
  • Best for comparing lump-sum returns.

B. XIRR (Extended Internal Rate of Return)

  • Used for SIPs.
  • Since SIP involves multiple cash flows at different dates, CAGR cannot be used. XIRR calculates the consolidated return.

Comparison: Point-to-Point vs Rolling Returns

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Exam Notes: Writing the Answer

Question: "Why are Rolling Returns considered a better measure of mutual fund performance than Point-to-Point returns?" (12 Marks)

Model Answer:

Point-to-Point (Trailing) Returns: They measure the growth between two specific dates.

  • Flaw: This creates a "Timing Bias." If the end date coincides with a market bull run, the returns look artificially inflated. If the end date is a crash, returns look unfairly poor.

Rolling Returns: They measure the performance for a specific holding period (e.g., 3 years) on a continuous rolling basis over the fund's history.

  • Advantage: It considers thousands of "entry" and "exit" dates. It shows the range of returns (Minimum to Maximum) an investor would have experienced regardless of when they invested.

Conclusion: Rolling turns reveal the consistency and probability of generating a return, making it the gold standard for analysis.

Summary

  • Point-to-Point: Simple but biased snapshots (e.g., "1 Year Return").
  • Rolling Returns: Series of returns over moving windows. Measures consistency.
  • XIRR: Required for calculating returns on SIPs (multiple cash flows).
  • Rule: Always ask "How consistent?" not just "How much?".

Quiz Time! 🎯

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