Assess long-term performance consistency & choose the right Mutual Fund

Investing based on past returns? Here’s what you should know.

In our previous article, we learnt why relying on long term track record and the consistency to choose a mutual fund is as important as choosing the right players for a Cricket team.

We are back with more tips for your investment journey. Learn the method of rolling averages to evaluate ‘consistency’ of a fund and make informed investment decisions easily.

First, let’s understand the meaning of ‘returns’. What does it really mean to say an “X fund gave a 3 year annual return of 10% as on 31st August 2020?”

It means for ₹100 invested on 31st August 2017 (exactly 3 years back), the value has grown to ₹133 as on 31st August 2020. i.e. the fund has generated an annual return of 10% as on 31st August 2020 in the period dating back to 3 years.

Such a return is also referred to as “point to point return” since they are calculated from one point to another point.

As an investor, you should remember that returns from Mutual Funds are never fixed and hence a fund should not be judged based just on the returns earned only during a specific period.

Buying a fund based on returns for a specific period such as 1 or 3 years is like buying a product from an e-commerce platform just by looking at the rating given by the most recent buyer of that product and not considering the ratings given by hundreds of other buyers previously and over time.

Since mutual funds are always attracting investments daily from investors, it makes good sense to calculate returns earned in different periods to evaluate a fund’s performance consistency.

So how can a fund’s long-term performance consistency be evaluated?

Here’s an example:

Look at the 3-year returns of investments made on different dates, viz. 31st August 2017, 31st July 2017, 30th June 2017 and so on for a long enough period depending on the category of funds being evaluated.

• For Debt funds, you can analyse such data over 3 or 5 years to assess the performance consistency.
• For Equity oriented funds, you should look at a longer term view of 7 to 10 years.

For Debt funds, one can also analyse 1 year returns in a similar manner to the 3 year example here.

In the above example, we have looked at investments made at monthly intervals, i.e. 31st August 2017, 31st July 2017, 30th June 2017 and so on. You can also consider investments made at daily intervals.

Such calculations of returns for different periods measured for multiple dates are known as rolling returns.

Once the data for rolling returns is obtained using the above method, how should an investor analyse it?

For the purpose of illustration, we gathered 3 year annualized returns data for investments made in one of the equity funds at each month end from August 2010 to August 2017 which is presented below. (Since we are analyzing this at the end of August 2020, the investment made on 31st August 2017 will be the latest investment that completed 3 years).

The table below shows data starting from the first investment on 31st August 2010 till the 85th investment on 31st August 2017.

The above data is shown for illustration purposes only. Please note that only a few return data points are shown above for illustration and not the entire data range. Past performance may or may not be sustained in the future.

We can then calculate multiple statistics such as average, minimum and maximum (see above table) to evaluate the consistency of the fund over a long period along with checking how often the fund delivered returns that missed or matched your expectations.

The table below shows data for the above fund under consideration. Such data can also be compared across funds to assess the relative consistency of funds.

The above data is shown for illustration purposes only. Past performance may or may not be sustained in the future.

We strongly recommend a similar structured performance consistency analysis before shortlisting the right funds to invest in. On PhonePe App we therefore show average rolling returns of funds instead of point to point returns.

The idea is to not be swayed by short term performance of funds and focus on assessing long-term performance consistency of funds. Choosing the right mutual fund can make a big difference in the overall wealth that an investor can accumulate through systematic and steady efforts. Start your investment journey with Mutual Funds today.

Mutual Funds investments are subject to market risks, read all scheme related documents carefully before investing.

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