The Return on Investment in a mutual fund is one of the main concerns that every investor has while he or she is making a decision to invest in a particular fund. Only, and only if, the return is commensurate to, or worth the risk, then the investor will show confidence in the fund and put his or her money in it.
What is the Return on a Mutual Fund Scheme?
Return or Return on Investment (ROI) refers to the sum that an investment gives you over a set term period and it is measured in percentage terms. The ROI shows the increase and decrease in the value of investment in the period.
The returns are usually calculated using the following four ways –
- Absolute Returns,
- Simple Annualised Returns,
- CAGR (Compounded Annual Growth Rate),
- XIRR (for calculating SIP Returns).
What is NAV? What is the role of NAV in calculating returns?
NAV is the Net Asset Value or the market value of the securities held by the scheme divided by the total number of units of the scheme on the stipulated date. The NAV varies on a daily basis and is calculated as –
NAV = (Assets – Liabilities) / Total number of outstanding units.
NAV is crucial to understanding the returns on the investment.
What is meant by Absolute Return?
In simple terms, absolute returns, or total returns, refers to the return that a mutual fund provides over a stipulated period of time. The main consideration is the initial investment amount and the maturity amount. It does not place any importance on the tenure of the investment. It is measured in percentage terms – and it shows the depreciation or appreciation of an asset or a mutual fund.
This method of calculating absolute returns is usually used when the holding period of the investment is less than one year.
Absolute return investment strategies include but are not restricted to, leverage, arbitrage, futures, derivatives, options, and unconventional assets.
How is Absolute Return Calculated?
Absolute returns are calculated as follows –
Absolute Returns (%) = (Current Value – Principal Investment) * 100
Principal Investment
For example,
The current value of the investment is Rs. 15,000.
The principal Investment of the investment is Rs. 10,000.
The absolute return is 50% as it is (15000–10000)/10000*100
It is important to note that 50% of earnings could have occurred over a few months or a few years. Looking at these figures will offer no clarity regarding the period taken to earn this amount. It does not give clarity on the growth potential of the investment.
A more simplistic formula for the same is Absolute return = (Current value/initial value) – 1
What are the features of Absolute Returns?
Absolute returns aim at generating positive returns and it generally hosts a diversified portfolio to spread risks of the fund. An effort is made by the fund manager to decrease the volatility of the fund and it is independent of benchmarks. In fact, it is actively adjustable to equity market movements.
What is the importance of Absolute Returns?
Absolute return analysis is used by those who are willing to take risks for short and long-term gains. It is simple and straightforward to calculate and is not impacted to a great extent by the market volatility. Absolute returns are essential to ensure dynamic risk management.
What is the difference between Absolute and Relative Return?
| Absolute return | Relative Return or Alpha |
| It is a return over a period of time. | It refers to the difference between the absolute return of an investment and its benchmark over a period of time. |
| As there is no reference period, a high absolute return is not necessarily proof of the investment being good. | A high alpha is an indicator that the investment made is good. |
| An absolute return makes no such indication. | The relative return shows if the primary purpose of the mutual fund has been fulfilled i.e. if the fund has been able to outperform the benchmark. |
| The absolute return has limited use. | Relative return is a more popular measurement of the returns generated by the fund. |
What is the difference between Absolute and Annualised Return?
Absolute returns are easier to calculate but cannot be used for the comparison of returns on two investments. Annualized returns, on the other hand, are harder to calculate, but can be used on a comparative basis. Usually when the calculation is for a period of less than one year then absolute returns are used. But if it is for a time period greater than one year, then annualized returns are used. For point-to-point returns calculation, absolute returns are used but for average yearly returns, annualized returns are used.
Is CAGR a better evaluator than Absolute Returns?
Absolute returns can be used when investors are looking to assume some risk in exchange for the potential to earn high returns. Whereas, Compounded Annual Growth Rate (CAGR) accounts for the tenure of the investment. This helps this measure to provide a clearer more accurate picture of the growth potential of the investment. CAGR is usually calculated as – CAGR (%) = Absolute Returns / Investment tenure (years). This can be used to evaluate one’s investment in light of not just higher, but also faster returns.
Conclusion
There are many ways of measuring returns on your mutual fund investment depending on the time period and the type of return evaluation you are looking for. Choose the right tool so that you can get the right investment returns which can help you make decisions to hold or sell that particular investment.
FAQs on Absolute Return
- Is there a reference period for calculation of absolute return?
No, there is no reference period for absolute return.
- Can absolute return be used for comparison of two different investments?
Usually, absolute returns are not used for comparison between two investments.
- For what time period will absolute return provide the most apt depiction of the return on investment?
Absolute return provides the most accurate information when it comes to a one year period.
- In what terms are returns usually calculated?
Returns are usually calculated in percentage terms – the same holds true for absolute returns, CAGR etc.
