Rolling returns play a crucial role in evaluating mutual fund investment returns. It offers a comprehensive picture of a fund's performance across various time frames, giving you deeper insights into its historical return trends. Understanding the concept of rolling returns, how it works and the effective methods for analysing these returns is essential to make informed investment choices.
Rolling return is a method used to assess the average annual return of a mutual fund over various periods within a larger investment horizon. Unlike traditional returns, which rely on specific start and end dates, rolling returns offer a continuous, overlapping view of the fund's performance.
It examines the fund’s performance across different holding periods, such as one year, three years, five years, or any chosen timeframe. This approach allows you to gauge the fund's consistency under different market conditions. Additionally, it helps you assess its volatility, enabling a more informed evaluation of the future performance of a mutual fund.
You can calculate the rolling returns of mutual funds by following the step-by-step procedure explained below:
Select the initial date for your calculation, such as the beginning of a specific year, quarter, or another relevant point in time.
Choose the rolling period that you want to analyse. It could be weekly, monthly, quarterly, 1 year, 3 years, or 5 years. It is determined by how often you wish to evaluate the returns.
Begin with the chosen starting date and calculate the returns for the set time frame. Then, move the start date forward by a day, week, or month (based on your preference) and recalculate. Repeat this process across the intended time span.
After gathering all the returns, compute the average to determine the rolling return.
Let us take an example to understand the calculation process of rolling returns in mutual funds.
Suppose you have a mutual fund with these annual returns over the past five years:
Year 1: 7%
Year 2: 14%
Year 3: 6%
Year 4: 13%
Year 5: 10%
Calculation for First 3-Year Period:
To find the first 3-year rolling return, calculate the average return from Year 1 to Year 3: (7% + 14% + 6%) / 3 = 9%
Calculation for Second 3-Year Period:
Now, shift the period by one year and calculate the average return from Year 2 to Year 4: (14% + 6% + 13%) / 3 = 11%
Calculation for Third 3-Year Period:
Move the period forward again by one year and calculate the average return from Year 3 to Year 5: (6% + 13% + 10%) / 3 = 9.67%
So, your 3-year rolling returns will be:
From these results you can say that the returns of this mutual fund are fairly stable, mostly ranging between 9% and 11%. Additionally, there are no sharp drops or surges, meaning the fund is steady over time.
Rolling return is a crucial tool for analysing mutual funds as it offers several key advantages. These include:
By examining rolling returns, you can identify funds that have consistently provided strong returns over various periods. This insight helps in making more informed investment decisions.
You can use rolling returns to compare how different mutual funds perform across various timeframes. This comparison helps in selecting the fund that aligns best with your investment goals.
Analysing rolling returns also aids in assessing the risk-adjusted performance of mutual funds. This process helps you understand the level of risk associated with each mutual fund, enabling you to match your investments with your risk tolerance.
Rolling returns have several valuable applications for mutual fund investors, which are as follows:
It offers a dynamic view of a fund’s performance, helping you evaluate its consistency and spot potential concerns, such as prolonged underperformance or high volatility.
Comparing the rolling returns of different funds enables you to optimise your portfolio by choosing funds with complementary performance patterns, which helps minimise risk while enhancing potential returns.
Rolling returns allows you to refine your strategies by highlighting the ideal holding periods for various funds or asset classes, thus allowing you to adjust your investment horizons accordingly.
Rolling returns allow for effectively benchmarking a fund’s performance against relevant market indices or similar funds, offering a more comprehensive comparison than traditional return methods.
Using risk-adjusted rolling returns, you can effectively control your portfolio’s risk exposure and ensure your investments are in line with your risk tolerance.
To effectively compare mutual funds using rolling returns, it is essential to go beyond just the average return and analyse the distribution of returns over time. This approach helps you understand the consistency of a fund's performance, revealing whether it delivers stable returns or has periods of significant highs and lows. For example, two funds might have similar average rolling returns, but one could be more consistent, while the other may experience extreme fluctuations.
By studying the rolling return distribution, you can identify how often a fund posts negative or unexpectedly low returns, providing insights into its risk level. A fund with frequent low periods may be riskier, even if its average return appears high. Additionally, reviewing the range of returns gives you a clearer picture of how the fund performs during both market upswings and downturns.
This analysis enables you to choose funds that align with your risk tolerance and investment goals by identifying options with steadier returns over time.