Mutual funds are highly popular among retail investors owing to their high returns and portfolio diversification. The performance of a mutual fund scheme can be assessed by looking at various performance indicators including absolute returns, annualized returns, rolling returns, etc.
This article aims to differentiate these performance indicators along with explaining how each type of return is calculated.
Absolute Return of a mutual fund refers to the amount of total change in the value of a mutual fund investment at the time of redemption.
For example, Mr. A invests Rs. 1 lakh in a mutual fund scheme in January 2016. The value of the mutual fund invests stands at Rs. 1.3 lakh in January, 2019. Thus, the absolute return earned by Mr. A on his investment over a period of 3 years can be calculated as follows:
(Final Investment Value – Initial Investment Amount)
Absolute Return = ————————————————————————- X 100
Initial Investment Amount
Absolute Return on Mr. A’s investment over 3 years = ————————————– X 100
Absolute Return on Mr. A’s investment over 3 years = 30%
Absolute return is always expressed in the form of a percentage (%)
Annualised Return refers to the return earned on a mutual fund investment on an yearly basis. It assumes that the investment has grown at a constant rate. Let’s better understand annualised return by calculating the annualised return of the above quoted example.
Annualised Return = (Final Investment Value ÷ Initial Investment Amount)^ (1/number of years) – 1
Annualised Return on Mr. A’s investment = [(130000/100000)^(1/3) – 1] = 9.04%
Thus, Mr. A’s investment grew at an annualised rate of 9.04% every year for 3 years.
Weighted Average Return
Weighted Average Return refers to the annualised return of a mutual fund scheme taking into account the weightage it has given to its different holdings.
For example, Mr. X has invested Rs. 1 lakh in a mutual fund which has 3 holdings – A, B and C. Let’s assume the mutual fund scheme has invested 50% of its assets in A, 30% in B and 20% in C. The annualised returns generated by A, B and C are 5%, 20% and 10% respectively. The weighted average of the scheme can be calculated in the following manner:
(PW1 * R1) + (PW2 * R2) +……..+ (PWN * RN)
Weighted Average Return = ———————————————————————
Total Portfolio Weightage
(PW1 = Portfolio weight of Holding 1; R1 = Holding 1 return; PW2 = Portfolio weight of Holding 2; R1 = Holding 2 return; N= Total number of holdings)
(50%*5%) + (30%*20%) + (20%*10%)
Weighted Average Return on Mr. X’s investment = ——————————————————-
(50% + 20% + 30%)
250% + 600% + 200%
Weighted Average Return on Mr. X’s investment = —————————————— = 10.5%