When it comes to evaluating mutual fund performance, you give the most weightage to past performance. The latest 1 year, 3 year or 5 year returns play a significant role in determining which fund will get your money. And it is a fact, because most funds which display superior recent performance, tend to see larger investments coming to them than other funds.

These past returns are called **trailing returns**, since they are anchored to a recent date that you choose.

**But are trailing returns the most relevant measure to evaluate a mutual fund’s performance? Should it be the basis on which you invest your money?**

Let’s examine these questions.

So, with trailing returns you will get to see a 1 year, 3 year, 5 year, 10 year or since inception returns of a mutual fund. If you had invested exactly 1 year, 3 year or 5 year or at the inception of the fund, trailing returns would tell your annualised return over that time period, anchored to the last date that you choose.

For example, if today is Feb 1, 2016 and you are looking at 3 year return, it would be calculated as a difference between the NAV as on Feb 1, 2013 and Feb 1, 2016. The result would be annualised to get the average yearly return.

However, trailing returns measure performance for just one block of time and in that sense they suffer from a recent performance bias. If there has been a recent great performance of the fund, say in the last 1 year, it can skew the overall annualised results. In fact, if you were to move your anchor date 1 month here or there, you could see a completely different picture for a fund.

With trailing returns, you can see a super 10 year performance but a not so good 1 year or 3 year performance. **As an exercise**, look up the past returns for HDFC Equity Fund or HDFC Top 200 Fund. FYI, both funds are amongst the top 10 in terms of size. **What do their trailing returns tell you?**

Here are 4 funds with their trailing returns. For the purpose of study, the four funds have been chosen from different categories. (Click on the scheme names to read their CVs.)

- Quantum Long Term Equity Fund
- Sundaram Select Midcap Fund
- HDFC Prudence Fund
- Franklin India Bluechip Fund

**Note**: The data is based on NAVs as on Feb 1, 2016. All returns are in percentages.

Since trailing returns are just one block at a time of 1 year, 3 year, 5 year or 10 year, they tend to assume that you invest only once as on a particular date and measure the result from there. The reality is very different.

In reality, you tend to invest over several years, in fact many times during a year. For example, through SIPs.

Your mutual fund performance measure should take this fact into account too. No?

So, yes trailing returns are not all that perfect.

**How to overcome this shortcoming of trailing returns?**

## Enter the world of Rolling Returns

That is where **Rolling Returns** come into picture.

The idea behind calculating rolling returns is to measure not just one block of 3 or 5 or 10 year period but to take several such blocks of 3 or 5 or 10 year periods at various intervals and see how the fund performed over those periods.

So, while with trailing returns you would take just a 3 year period ending today. With rolling returns, you would take many such 3 year periods over the history of the funds with rolling intervals of 1 month, 3 month or 1 year.

So you keep shifting the end date by 1 month and you will have, say for a 10 year old fund, about 84 performance data points. Now you will see a better picture of how the fund performed across these 84 3-year periods.

You could, instead of 1 month, shift the intervals by 1 year. In that case, you will have 7 data points of 3 year periods.

**You get the point of rolling?** It is the interval or frequency for which you calculate the returns.

You could calculate rolling returns for 1 year, 3 year, 5 year, 10 year, 15 years with rolling intervals or frequency of 1 week, 1 month, 3 months, 6 months, 1 year, 3 year, 5 year, so on and so forth.

When you do this you would measure the consistency of performance of the fund better. You can look at for how many of the observed time periods did the fund deliver positive returns as well as negative returns right through the history of the fund.

**Let’s look at the rolling returns of the 4 funds that we listed above with their trailing returns.**

We will use 2 sets of rolling returns. One, with a 3 month rolling frequency. What it measures is that if you would make one block of investment every 3 months into a fund and you stay invested for 3 years, what would be the result?

The second with a 1 year rolling frequency. The difference is that you make investment once in a year at the beginning and then hold for 3 years.

In both cases, the measurement period taken into account is from January 1, 2007 to December 31, 2015 – long enough to cover a market crash and an upswing.

**Why 3 years?** We would take that as the minimum time frame for equities to deliver. Having said that, you could do it for 5 years too.

### 3 year returns with 3 months rolling interval

### 3 year returns with 1 year rolling interval

All returns are in percentages.

**Making sense of the tables**:

- The
**Total observations**are the number of blocks of rolling returns calculated. In case of 3 month rolling, there are 25 blocks; in case of yearly rolling, it is just 7. - The
**Median Return**is the middle value of all the values (*arranged in ascending or descending order*) that separates the higher half of returns from the lower half of the returns. - The
**Average Return**is the mean, that is, sum all the returns and divide by the count. - The
**Max Return**is the maximum return in any of the blocks of rolling returns. - The
**Min Return**is the minimum return in any of the blocks of rolling returns. - The
**Standard Deviation**is the measure of the volatility of the returns from the average or mean return. The higher it is, the more volatile the fund is. - The
**Loss Periods**show in how many of the rolling blocks did an investment in the fund lose money.

As you would notice, the picture is quite different from the one shown by trailing returns. With rolling returns, you can see a range of performance across blocks of time. They thus appropriately capture market behaviour and also impact of fund manager’s investment calls, if any, for those periods.

The impact of highly favourable or unfavourable events or market situations also becomes visible in measuring rolling returns. You get to see a more accurate track record of a fund’s performance.

**Based on the above, which of the above funds makes the cut for you? **

Unfortunately, there is no good online rolling returns calculator that could be found. Do you know of one? Your questions and feedback are welcome.

**Some points to note for calculating rolling returns**

- You can also add the performance of the benchmark on a similar basis as for the fund that you are calculating the rolling returns for. You do need a point of comparison, don’t you? So, you will have the fund rolling returns as well as the benchmark rolling returns. Now you can also compare in how many rolling periods did the fund outperform or underperform the benchmark.
- For equity mutual funds, it would be better to have data for as along a period as possible. 10 years, 15 years, since inception is great.

Himanshu says

If our time horizon is 10 years n can take very aggressive risk , even then we should include large cap mutual fund in portfolio or simply include multicap n mid/small cap mutual funds. What is the ideal mutual fund portfolio for sip of rs 12000/month for 10 yrs n high risk taking capacity

Vipin Khandelwal says

Dear Himanshu,

In my view, it is a personal choice. As long as you understand the associated risk and volatility, it is fine. Though a large allocation to mid and small caps is ideal only for the long term of over 10 years plus.

Multi-caps do invest in large cap too. Currently most multi-caps are positioned mostly towards large caps. But they can make a shift in strategy and move away towards other caps.

Hope this helps. Thanks.

Himanshu says

Thanks for prompt .reply.

I am investing 2500 sip in each of the following funds :

Idfc premier equity

Franklin high growth

Franklin small cap

Icici pru value discovery.

My time horizon is 10 yrs.

I want to start additional 2500 sip in another mutual fund . I am wondering whether I should invest in large cap fund such as HDFC 200 (THOUGH IS HAS NOT PERFORMED , BUT MR PRASHANT JAIN IS CONFIDENT OF CYCLICAL REVERSAL) OR DSP BR MICRO fund

Vipin Khandelwal says

Let me add to the information for your decision. On the risk return spectrum, the two funds are on two different sides. What do you want to add to your portfolio?

himanshu says

thanks for prompt reply again. I am asking expert guidance that whether it is advisable to keep large cap fund into the portfolio even if time horizon is 10 yrs . ok let me put up this way . Had it been you , where would you have invested additional 2500 sip into ?

regards

Jai says

Perhaps its time for Unovest to provide such a calculator to compute rolling monthly returns. Thanks.

Vipin Khandelwal says

Dear Jai

Thanks for the input. Unovest will have it in due course. Thanks again.