Absolute Vs Annual Vs Trailing Vs Rolling Returns

Calculating Returns should be simple, no? But we are humans. We don't like simplicity. We love making everything complex. But let me try and present this complex topic in as much simplicity as it so truly deserves.

The first thing that we typically search for in any investment product is how much return it has given in the past. We are also curious to know how much returns are we getting from the investments we have made so far.

There are different ways of looking at return on investment. And you must know what kind of returns to use in what situation. 

We talked about various ROI methods viz CAGR, IRR and XIRR in one of or earlier blogs. Click here to read that blog. The above methods are typical and specialized examples of different types of returns.

In this post, we will take a step back and understand the underlying type of returns. We will talk about 4 TYPES of RETURNS viz Absolute, Annual, Trailing & Rolling Returns. Everything else (including the methods like CAGR, IRR or XIRR) will fit onto these four types of returns.

Type 1: Absolute Returns

Absolute returns are a measure of the overall growth in an investment over any period of time. It is expressed as a percentage of the invested capital. These are also called as Simple Returns, primarily because they are very simple to calculate.

Example

For example, if an investment has grown from Rs 1 lakh to Rs 1.5 lakh over a span of two years, the absolute return is 50%. The investment has grown by 50% over the investment period - which happens to be two years in this case. If you stay invested for a longer duration, it is very likely that your absolute returns will keep increasing - way beyond 100% as well.

Advantages

- Very simple to calculate
- Have various uses in accounting

Limitations

- Simple Returns or Absolute Returns does have accounting use, but do not make a lot of sense for a retail investor.
- This return cannot help us compare two investments done over different time periods.
- They find no use in trying to find whether it makes sense to stay invested or move to a better investment. 

What we need is an annualized form of return so that we can effectively compare returns from one asset to another and take informed decisions.

Type 2: Annual Returns

The annual return of an investment product shows its performance for one (1) calendar year. So, you can check the consistency in the performance of an investment product if you check the annual returns year after year. And the best part is that the annual return calculation is a fairly simple process.

You need to just know the investment price (or NAV of a mutual fund scheme) at the end of the current calendar year and the previous calendar year.

For example, let’s calculate the annual return of the Nippon India Small Cap Fund in 2021.

Annual Return = (NAV on Dec 31, 2021 – NAV on Dec 31, 2020)/ NAV on Dec 31, 2020

NAV On Dec 31, 2020 Rs. 54.54

NAV On Dec 31, 2021 Rs. 94.97

Difference in NAV         Rs. 40.43

Annual Return from Nippon India Small Cap Fund in 2021: 74%

Following this method, you can determine the annual return of any investment product year after year. Let us extend the above example and illustrate how the annual returns can give you a fair idea about a mutual fund scheme’s performance.

The following table shows the annual returns of the Nippon India Small Cap Fund over the last 5 years.

Year Annual Return of Nippon India Small Cap Fund

2017     64.41%

2018    -15.61%

2019      -1.19%

2020    30.88%

2021    74.36%

Looking at the year-on-year returns, you can get some idea about the consistency in a fund’s performance and can also gauge the volatility across various market scenarios over the last 5-year period.

Advantages

- Still fairly easy to calculate and compare performance over a single year.
- Same type of annualized return when done over multiple years can show us the returns consistency over a period of time.

Limitations

- An investment or a fund could beat its benchmark for most years. Yet, the fund could be underperforming during the overall period under observation. It happens because you are looking at multiple years of annual returns. And it is difficult to estimate net returns over a period.
- You only look at annual returns and can only make a guess of overall returns by looking at annual returns.
- Taking a simple average of annual returns may not be the best judge to estimate the overall returns.
- Multiple years of annual returns do not show the impact of compounding across these years. So, you do not get to see the return a fund has accumulated over the period.

Example

Let’s understand this limitation with an example. Let us say that a fund has performed in the following manner against its benchmark.

Year     Fund Return Benchmark Return

2015         10%         9%

2016         4%         3%

2017         -12% -8%

2018         -23% -7%

2019         14%         11%

2020         16%         12%

2021         37%         4%

On the face of it, you see that the fund has beaten its benchmark in 5 out of 7 years, i.e., 2015, 2016, 2019, 2020 and 2021. So, your first impression is that the fund should have outperformed its benchmark. But when you calculate the return, the fund is actually underperforming its benchmark. This is primarily because the fund did not do as well in the earlier years (up to 2018) than what it did in the later years, and compounding plays a bigger role for the investments and returns in the earlier years.

If you had invested Rs. 100 in the fund at the start of 2015, it would have grown to Rs. 141 by 2021. On the other hand, if you had invested in the benchmark index, the same Rs. 100 would have grown to Rs.160 by 2021.

Therefore, annual returns do not show a clear picture while comparing the net returns of multiple investment instruments over a long period. And this is where trailing returns come into the picture.

Type 3: Trailing Returns

Trailing return helps you measure the average annual return between two dates. So, we use the compounding formula to calculate this return. This is the same formula that we used for CAGR method of returns calculation. CAGR is one of the methods used for calculating Trailing Returns.

Trailing Returns = (Current Value/Starting Value) ^ (1/Trailing Period) – 1

Example

Say, today’s date is January 3, 2022. You want to check the 3-year trailing return of the Parag Parikh Flexi Cap Fund. Here’s how the trailing return calculation works:

NAV on Jan 3, 2022= 54.58

NAV 3 years ago, i.e., NAV on Jan 3, 2019 = Rs. 24.01

Absolute Return = (54.58 – 24.01)/(24.01) = 127.32%

3-year Trailing return = {(54.58/24.01)^(⅓)} – 1 = 31.49% (Using CAGR formula)

As you can see in the example, the trailing return shows a return between two dates. Due to this, comparing returns from two funds or finding the return over a period becomes easy.

Advantages

- Compounded as well as annualized returns can be calculate using Trailing Returns, which is neither possible with Absolute Returns or Annual Returns.

Limitations

- Trailing returns measure performance for just one block of time and show a point-to-point return. Thus, the trailing return of a fund doesn’t necessarily show the consistency or volatility of a fund. For example, if two funds have similar returns, you cannot find which one is the more volatile fund. It is possible that more than one funds deliver the same average annual return (CAGR returns) over the last 10 years, with one fund being more volatile than the other. But only looking at the 10% trailing return would never give you any idea about the volatility in both the fund’s past performance.
- Depending on when you are investing and withdrawing, your trailing return can change significantly. That is because of the nature of equity markets. As markets keep moving up and down, there is a possibility that you may enter during a rally and then exit during a correction or vice versa. For example, say you invested in SENSEX for a 10 year period. Depending on the date of investment and redemption, your returns may vary significantly.
- So, while Trailing Returns using CAGR method takes care of the compounding, it does not take care of multiple small investments (SIP style) or withdrawals in between the two dates. Also, it doesn't account for volatility for the in-between period.

Type 4: Rolling Returns

Rolling return is calculated for a particular period on a continuous basis (or fixed frequency). Simply put, it is like calculating trailing returns on a daily basis - yes, you read it right - on a daily basis.

Example

Suppose we want to see the 5-year return of a fund over a long period, say, between 2010 to 2020. So, the rolling return would mean calculating the trailing 5-year return on each day during this period.

You will calculate the trailing 5-year return as on 1st January 2010, 2nd January 2010, and so on till 31st December 2020. And then average out these returns to come up with the rolling return.

It will show you a spread of returns had you invested on any day during this period (2010 to 2020) for a 5-year period. This spread is useful to gauge the volatility or consistency in a fund’s performance. 

IRR and XIRR are specialized methods that can be used to calculate Rolling Returns. Since these are daily returns averaged out later, they can also account for in between investments and withdrawals, and are therefore ideally suited for irregular or regular systematic investments done via SIPs, SWPs and STPs.

Advantages

- Most accurate of all types of returns.

- Has less dependence on the start and end values since there is a daily return calculation and averaging of returns.

Limitations

- Rolling returns are pretty complex to calculate and require a good understanding of the mechanics for accurate calculation. 
- In most cases, they are never calculated manually. You would need the assistance of excel formulas or customized macros to calculate the Rolling Returns.

Summary

To sum up, no single return should be your sole focus as an investor. Narrowly focusing on any one of the returns would mean you are losing sight of the big picture. Ultimately, you need to consider annual, trailing, and rolling returns to make prudent investment decisions.

Each of these returns are used in different scenarios. e.g. Real Estate is a one time investment and CAGR Trailing Returns are the best way to find the returns. Mutual Funds is typically a staggered investment and IRR/XIRR Rolling Returns are the best way in this case.

Regards

Manoj Arora
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