Mutual Fund-Returns

Mutual fund advisors say investors should learn to live with lower returns from their mutual fund investments in future. No, it has got nothing to do with the current volatility in the stock market. Blame it on the `re-categorisation’ exercise carried out by the mutual fund houses for your plight. Mutual fund advisors believe that the `strict’ new investment norms would not allow fund managers to cash in on every available opportunities in the market like earlier.

After the re-categorization, the mandate of investing for schemes is very strict. Every category has to follow specific rules, making it difficult for fund managers to juggle the portfolio. This will result in lesser returns in the future.

The new Sebi norms stipulate stricter investment guidelines for mutual funds. Earlier, many schemes used to swing between, say, mid cap and small cap stocks. Some large caps also used to cash in on mid cap rallies. This resulted in many schemes outperforming most market cycles. But that might not happen now. Fund managers cannot opt out from small caps or large caps when they start under performing. Out performances will now be totally based on stock picking skills.

The point is: unlike earlier, your fund manager can’t deviate from his investment mandate to post superior returns. Now, every scheme would be forced to remain true to its label because of the mandatory minimum investment criteria. Earlier, investment mandate of many equity schemes was `investing in equity and equity-related investments.’ This meant the scheme would become a mid cap scheme when mid cap segment is doing well; it will start picking up small cap stocks when going is great in the small cap segment, and so on.

Some mutual fund advisors have asked investors to postpone their portfolio review for the same reasons. Many investors review their portfolios quarterly. We have asked such clients to review the schemes in the next quarter. Because the investment style of the schemes has changed in this quarter and the judging them on returns at this point wouldn’t be a good idea .

Types of Mutual Fund Returns

Absolute Returns

Absolute Returns or Point-to-Point returns indicates the increase or decrease in investment, in terms of percentage. The time taken for this change is not accounted for. The absolute returns method of calculating returns is used for mutual funds with tenure less than 1 year. If the period is more than one year, the investor has to calculate annualized returns.

Annualized Return

As the term implies, annualized returns measure the amount of growth in the value of your investment on an annual basis. For instance, let’s say that you made an investment of Rs.1 lakh in a MF scheme. In a span of three years, your investment has grown to Rs.1.4 lakh. In this case, your absolute return is 40%, but your annualized return is 11.9% because of the compounding effect.

Total Return

It refers to the actual returns you have accrued from the investment. It includes dividends as well as capital gains.

Trailing Return

It is the annualized return over a particular trailing period which ends today.

Point to Point Return

It is the annualized return recorded between two points of time. All you need to calculate point to point returns is the start date and the closing date of a mutual fund scheme.

Annual Return 

As the term suggests, annual return essentially refers to the return earned from a scheme between the 1st of January and the 31st of December of a particular year. For instance, in case a scheme’s NAV on the 1st of January is Rs.100 and on the 31st of December is Rs.110; your annual return shall be 10%.

Rolling Returns

They refer to a scheme’s annualized returns over a particular period of time. Rolling returns periods can be daily, weekly or monthly and shall be used until the last day of the duration in comparison with the benchmark of the scheme (for instance, Nifty, CNX – Midcap, CNX – 500, BSE – 200, BSE – Midcap, etc.) or fund category (for instance, midcap funds, large cap funds, balanced funds, diversified equity funds, etc.)

Compound Annual Growth Rate is used to calculate the returns from mutual funds investment which has a holding period that exceeds a year. This would reduce the short-term fluctuations and volatility of the Net Asset Value of the funds. Under this method of calculating returns from mutual funds, it is assumed that the investment is growing at a steady pace

In order to calculate the Compound Annual Growth Rate (CAGR) manually, the equation is as follows:

CAGR = [(Current Net Asset Value / Beginning Net Asset Value) ^ (1/number of years)]-1

Methodology

Mutual Funds has employed the following parameters for shortlisting the mutual fund schemes.

1. Mean rolling returns: rolled daily for the last three years.

2. Consistency in the last three years: The three-year period is divided into smaller time periods each with a progressing weighting.

3. Downside risk: We have considered only the negative returns given by the mutual fund scheme for this. X = Returns below zero Y = Sum of all squares of X Z = Y/number of days taken for computing the ratio Downside risk = Square root of Z

4. Outperformance: It is measured by Jensen’s Alpha for the last three years. Jensen’s Alpha shows the risk-adjusted return generated by a mutual fund scheme relative to the expected market return predicted by the Capital Asset Pricing Model (CAPM). Higher Alpha indicates that the portfolio performance has outstripped the returns predicted by the market.

Average returns generated by the MF Scheme – [Risk Free Rate + Beta of the MF Scheme * {(Average return of the index – Risk Free Rate}

5. Asset size: For equity diversified funds, the threshold asset size is Rs 100 crore, and Rs 50 crore for balanced funds.

We have also conducted a back testing of our model portfolios. These returns are forward returns from the base date.

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