Why Rolling Returns Matter: A Smarter Way to Evaluate Mutual Funds

Introduction

Investment decisions are often influenced by recent returns, with many investors relying on the past 1-, 3-, or 5-year performance of a mutual fund. However, these trailing returns may not provide a complete picture, especially when dealing with volatile assets such as equities.

When evaluating an equity mutual fund, looking at its 1-, 3-, or 5-year returns can be misleading. If the stock market has experienced an upswing or downturn during that period, the fund’s performance could be disproportionately skewed, leading investors to either overcommit or avoid the fund entirely.

The Need for Rolling Returns

A more insightful approach to analyzing a mutual fund’s performance is through rolling returns. Rolling returns assess how an investment performs over different time frames, providing a broader perspective on its consistency and volatility.

Example: HDFC Flexicap Fund

(Disclaimer: This data is for illustrative purposes only and does not constitute an investment recommendation.)

Fund Details (as of August 3, 2024):

• Inception Date: January 1, 1995
• Assets Under Management (AUM) as of July 31, 2024: ₹61,572 Crores

At first glance, these returns appear highly attractive, but they do not reveal the complete risk-return profile of the fund. This is where rolling returns become valuable.

Rolling Returns Analysis

Rolling returns provide a better understanding of a fund’s performance across different time horizons, helping investors assess consistency, volatility, and downside risk.

Key Observations:

1. Volatility Reduces Over Longer Horizons: Over a 1-year period, the fund delivered returns as high as 179.39% but also suffered losses as steep as -53.57%. However, as the investment horizon lengthens, the range of returns narrows significantly, stabilizing after 10–15 years.
2. Probability of Negative Returns Declines: While the fund had negative returns in 21.4% of 1-year periods, this dropped to 6.92% for 3 years and almost disappeared for horizons of 10 years or more.
3. Better Predictability for Long-Term Investors: Over a 10-year horizon, the minimum return observed was 5.76%, and for a 15-year horizon, the lowest return was 11.43%. This suggests that investors who remain invested for the long term can potentially mitigate risk and benefit from market cycles.

Why Investors Should Focus on Rolling Returns

Trailing returns often capture only short-term performance and can be heavily influenced by temporary market movements or fund manager decisions. Rolling returns, on the other hand, offer a more reliable measure of performance consistency and risk exposure over time.

Key Takeaways:

1. Short-term market fluctuations can distort trailing returns, making them unreliable indicators of long-term performance.
2. Rolling returns provide a clearer picture of a fund’s historical behavior, helping investors assess its stability and risk-adjusted returns.
3. Long-term investing reduces the impact of extreme fluctuations, improving predictability and reducing the likelihood of losses.
4. Investors should use rolling returns to make informed decisions rather than relying solely on point-to-point performance metrics.

Conclusion

When investing in mutual funds, a well-rounded analysis that includes rolling returns can provide greater clarity on long-term prospects. Investors should prioritize consistency, stability, and downside protection rather than focusing on short-term outperformance.

Disclaimer:

Mutual fund investments are subject to market risks. Past performance is not indicative of future results. Investors should consult a financial advisor before making investment decisions.

This article has been refined with the assistance of ChatGPT. While efforts have been made to ensure accuracy, readers should verify data from official sources before making any financial decisions.