We cover how can investors analyze mutual fund returns effectively.

The Story

Mutual funds have become the preferred choice for investors seeking diversification and professionally managed investments.

Data also tells the same story. Investments in open-ended equity mutual funds more than doubled to ₹35,943 crore in November 2024, compared to ₹15,536 crore in November 2023.

As an investor evaluating a fund’s performance, you would typically consider its returns. A mutual fund scheme’s return can be calculated differently, each providing a unique perspective on the scheme’s performance.

Trailing and rolling returns are two methods to understand a fund’s historical performance and estimate future returns.

Before we proceed, it’s important to note that you don’t need to know the exact calculations. These numbers are usually readily available. What’s important is how to interpret them. Let’s start with trailing returns.

Trailing Returns
Trailing returns in mutual funds show the fund’s performance over specific past periods (e.g., 1 year, 3 years, or 5 years) ending on the most recent date.

For instance, if a mutual fund has a 5-year trailing return of 17.86%, it means the fund has delivered an average annualized return of 17.86% per year over the past five years.

The major drawback of trailing returns is that they don’t fully capture market fluctuations, often becoming either overly influenced or insufficiently incorporating those fluctuations.

A 5-year trailing return of 17.86% might seem impressive, but there might be instances when a fund delivered stellar returns of 50% in one year in a booming market but delivered just 5% or even negative returns in other years.

It only shows the average result, not the ups and downs during those years, failing to reflect the consistency of performance across different market cycles. So is there any better way to measure, you ask? Well, here comes the rolling returns.

Rolling Returns

Rolling return calculates how the mutual fund has performed over various holdings within the given timeframe. It gives averaged annualized returns for all the possible holdings within a timeframe.

Let’s use a hypothetical example to track the performance of an equity fund over the last 5 years, starting from January 1st, 2020. First, the annualized return of the fund from Jan 1st, 2020 to Jan 1st, 2025 will be calculated. Then, returns from Jan 2nd, 2020 to Jan 2nd, 2025. Then from 3rd Jan 2020 to 3rd Jan 2025.

Keep doing this every day, sliding the 5-year window forward. After calculating each 1-year return for all periods, you can look at the average rolling return for a clearer idea of the overall performance, smoothing out the impact of events like a market crash.

By calculating returns over multiple overlapping periods, rolling returns provide a better indication of the fund’s resilience across various market conditions.

To Conclude

While trailing return is simple to understand, it does not provide a very clear picture of consistency over market cycles, rolling returns, by averaging returns over multiple periods, offer a clearer view of long-term performance and consistency.

Understanding both helps investors make more informed decisions.