Evaluating Mutual Fund Performance: Rolling Returns vs Point-to-Point Returns

July 10, 2024 Mutual Fund

Comparing the historical returns of a mutual fund relative to its benchmark and peers is a key metric that helps investors shortlist mutual funds for their portfolio. There are various to evaluate a scheme’s returns, of which point-to-point returns and rolling returns are the prominent ones.

In this article, find out the difference between rolling returns and point-to-point returns of mutual funds. Also find out which of the two is a better tool for determining the performance of mutual fund schemes.

What are point-to-point returns?

A point-to-point return represents the growth in the net asset value of a mutual fund scheme between two specific dates such as 1 week, 6 months, 1 year, 3 years, 5 years, since inception, etc. In other words, it considers the beginning and end value of the investment to compute returns.

For instance, if you had invested Rs 10,000 one year ago and if it has grown to Rs 12,000 at present, your point-to-point returns will be 20% in absolute terms (Rs 12,000 – Rs 10,000)/Rs 10,000. If we calculate the same for a 3-year period assuming that the investment value has grown to Rs 15,000 from Rs 10,000, the point-to-point returns will be around 14.5% in CAGR (Rs 15,000/ Rs 10,000)^(1/3)-1.

Thus, point-to-point returns allow investors to see how an investment performed over a particular period of interest.

What are rolling returns?

Rolling returns are the average annualised returns of mutual fund schemes over specific periods such as 1 year, 3 years, 5 years, 10 years, etc. calculated at regular intervals throughout the investment’s history. In other words, a rolling return takes the average of all return points for the chosen period.

Rolling returns take into account the point-to-point returns for the length of time for which the investors want to analyse the returns (3 years, 5 years, 10 years, etc.) and roll it over a return cycle (such as 1 year), at a specific frequency (daily, weekly, monthly, etc.).

For instance, a 3-year rolling return will consider 3-year compounded annualised return (CAGR) on a daily frequency for the last 1 year. This means that to calculate the 3-year rolling returns as of June 30, 2024, returns will be rolled every day for a 1-year period i.e. from June 30, 2021 to June 30, 2024, June 19, 2021 to June 19, 2024, June 18, 2021 to June 18, 2024 (or the previous trading day in the case of weekend/holiday), and so on, till it covers around 250 trading days in the last 1-year period.

The above exercise will help derive the mean of the data series, i.e. the average of all return points for the chosen period. In the above example, it will be the average returns of three years. The higher the average, the better the fund has performed.

[Read: 8 Top Performing Mutual Funds of 2024 in India Based on 5 Year Rolling Returns]

[Read: 5 Top Performing Mid Cap Mutual Funds of 2024 in India Over the Last 5 Years]

[Read: 5 Top-performing Large Cap Mutual Funds of 2024 in India Over the Last 5 Years]

Rolling returns vs point-to-point returns: Which is better?

As the name suggests, the point-to-point return shows the change in NAV from one point (start date) to another point (end date). When analysing mutual funds, point-to-point returns may not be the best way forward because they just show the performance for the respective point in time and not over the period of time.

You see, markets go through various phases and cycles, which one cannot ignore while determining the performance of a mutual fund scheme. In the case of point-to-point returns, the performance may be influenced by certain key events that may have taken place during the beginning or end date of the period under review.

For instance, let’s assume that an investment in a mutual fund scheme was made five years ago, i.e., on June 20, 2019. Between then and now, the scheme NAV has more than doubled. But for the first two and half years, it generated lacklustre returns. In other words, the bulk of returns has come in the last two and a half years. Computing the point-to-point returns won’t give you any clue about the uneven track record of the scheme due to the recency bias.

Point-to-point returns do not tell you how consistently the scheme has performed over this period. On the other hand, the rolling return irons out the distortions and provides smoothed returns over the period chosen. Thus, it is a better means of assessing the returns for the mutual fund investor over the holding period.

In short, the following are the advantages of using rolling returns to evaluate a mutual fund’s performance:

✔ Gives you a more realistic picture of the performance

✔ Eliminates the risk of recency bias or any other

✔ Helps even out lop-sidedness on account of high market volatility

✔ Captures the returns across market phases (bull and bear)

✔ Help measure the consistency in returns and potential outperformance of the scheme

✔ Comparing the rolling returns of the scheme vis-a-vis its benchmark throws light on the value added by the fund manager.

To conclude:

Using point-to-point returns is a convenient way of computing mutual funds returns. However, it does not provide any indication of the interim volatility in the fund’s performance. For instance, if two mutual fund schemes generated similar returns in the last one year. However, there may be a sharp fluctuation in the performance of one of the funds between the starting and end period of investment, making it riskier. Thus, point-to-point returns will be misleading as it does not indicate the consistency of performance.

On the other hand, while rolling return is more complicated to compute, it gives a better picture of how an investment has performed across different market cycles by providing a richer understanding of its consistency. It helps investors understand the risks associated with the investment based on its volatility/fluctuation.

Thus, rolling returns are a better indicator of the consistency of a scheme’s performance over a given period.

But do note that past performance is not an indicator of future returns. Therefore, when evaluating and comparing mutual funds, investors must complement it with risk ratios and other key parameters such as portfolio characteristics. By incorporating them in fund analysis, investors can make informed investment decisions that align with their risk tolerance and financial goals.

This article first appeared on PersonalFN here