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Rolling Returns

The Importance of Rolling Returns in Investing

When investing in mutual funds, we are faced with a plethora of options ranging from schemes lying in different categories such as small-cap, mid-cap, and large-cap to schemes of different asset allocation such as equity, hybrid, and debt. The choice of the right mutual fund depends on several factors, such as your needs, your risk profile, and your investment horizon. However, an important factor to look out for when comparing different schemes is the rolling return.

Mutual funds provide a pathway to build wealth over time. Rolling returns is an essential tool to assess a fund’s historical returns over different time periods. As investors, we are cautious about the value of our hard-earned money. Hence, before choosing the right mutual fund, we try to evaluate the performance of mutual funds through various metrics.

Let's explore what rolling returns are, why they're important, and how they can help you make investment decisions.

Rolling Returns

Rolling returns provide a dynamic perspective on a mutual fund's performance over different time frames. Unlike traditional point-to-point returns, which are measured over fixed periods like one year or three years, rolling returns offer a more holistic view. They consider all possible investment periods within a chosen duration, which gives a clearer picture of a fund's consistency and its ability to deliver returns across changing market conditions.

How Rolling Returns Work?

To understand rolling returns, let's consider an example. Suppose we're interested in analysing a mutual fund's 5-year rolling returns over a 10-year period (1 Jan 2012 to 31 Dec 2022), and you have the daily NAV data of 10 years.

For each 5-year period within the 10-year span, calculate the fund's annualised returns. Start with the first five years (1 Jan 2012 to 31 Dec 2016), then shift the window by a day (2 Jan 2012 to 1 Jan 2017), recalculate, and so on. This results in a series of annualised returns for various 5-year periods.

The next step is to calculate averages. Once you have the annualised returns for all these 5-year periods, calculate the average return. This average return represents the fund's 5-year rolling returns over the 10-year period.

Why Rolling Returns Matter

  • Capturing Market Cycles- Rolling returns help investors account for the cyclical nature of markets. A fund might perform exceptionally well in one period and poorly in another. Rolling returns provide insights into the overall fund performance across different market phases.
  • Consistency Assessment- By calculating rolling returns, you can assess a fund's consistency in delivering returns. A high rolling return indicates that the fund has consistently performed well over various time frames.
  • Accurate and unbiased- Absolute returns might provide misleading information if they're calculated during periods of market extremes. Rolling returns offer a more balanced perspective, reducing the impact of extreme market conditions.

To conclude, rolling returns are a powerful tool for mutual fund investors who seek a deeper understanding of fund performance. By examining how a fund's returns change across various time frames, investors can make more informed decisions that align with their financial goals. Remember that while rolling returns provide valuable insights, they are just one aspect of a comprehensive approach to evaluating mutual funds. Combining rolling returns with other metrics and thorough research will contribute to more confident and successful investment decisions.