Understanding Mutual Fund Returns

Published On: 03-Jun-2019

While it is important to start investing early, it is equally important to review the mutual fund performance on a periodical basis. The most critical parameter on which the investment decisions are generally based upon are the mutual fund returns. Considering the importance of fair and standardized disclosure in respect of the mutual fund performance, SEBI has prescribed certain specific disclosure requirements for all the mutual fund schemes to follow. Before we discuss the types of mutual fund returns and the methodology to calculate such returns, let us first discuss the SEBI guidelines in this regard.

Importance of understanding mutual fund returns

SEBI Guidelines - Performance Disclosure for Mutual Funds on AMFI website.

Asset Management Companies (AMCs) shall disclose the performance of all schemes on the website of AMFI. AMFI shall facilitate the disclosure in the following manner

  1. In case of all schemes, the scheme returns vis-à-vis the benchmark return (Total Return Index) shall be disclosed in terms of CAGR for various periods viz. 1 year, 3 years, 5 years, 10 years and since inception.

  2. In addition to the above, in case of schemes falling in categories such as overnight funds, liquid funds, ultra-short duration funds, low duration funds, and Money Market Funds, scheme performance is also to be disclosed for a period of 7 days, 15 days, 1 month, 3 months and 6 months.

  3. The said disclosure should be made for all plans and shall be updated daily based on previous day NAV.

  4. The disclosure should include other important fields such as scheme AUM and previous day NAV.

How to calculate Mutual Fund Returns

Returns may be calculated in the following three manners:

  1. Absolute Returns

It is the simplest method of calculating the returns on your investment and may be calculated by dividing the current NAV of the scheme with the NAV at the time of investment and multiplying it by 100. The holding period is of no significance for calculating the absolute returns. For example, the NAV at the time of investment was Rs. 10 and the NAV at the time of redemption after 5 years is Rs. 25, the absolute returns of the mutual fund will amount to 150%.

  1. Annualized Returns

When the returns are being calculated for the periods less than a year, it is often preferable to annualize the returns to make the returns comparable with other mutual fund schemes. It is calculated by extrapolating the actual returns to a 12-month period. However, a simple extrapolation may again be misleading, if the returns for the shorter period contain any exceptional items, as the impact of such exceptional items gets magnified at the time of extrapolation. Annualized returns may be calculated as under:

(1 + Absolute Rate of Return) ^ (365/number of days)) - 1 

  1. Compounded Annualized Growth Returns (CAGR)

CAGR shows the rate of return the mutual fund scheme has given steadily on the investments (including the returns on the investment) over a period. It is calculated as below:

(((ending-value/beginning-value)^(1/number-of-years))-1*100 

CAGR is a better reflection of the mutual fund performance when the performance period is more than one year since it captures the power of compounding as well. For example, S&P BSE Sensex completed its 40 years on the 1st of April 2019 and has grown from 100 in 1979 to around 38,800 in 2019. As such, the index has given 388 times absolute returns in 40 years, calculating to 9x annual returns. However, if one calculates CAGR returns, it would result in around 16% annual returns. Even SEBI also prescribes the disclosure of CAGR returns over longer horizons of 1 year or more, considering the fair reflection of performance through CAGR method.

Disclaimers: The information set out above is included for general information purposes only and is not exhaustive and does not constitute legal or tax advice. In view of the individual nature of the tax consequences, each investor is advised to consult his or her or their own tax consultant with respect to specific tax implications arising out of their participation in the Scheme. Income Tax benefits to the mutual fund & to the unit holder is in accordance with the prevailing tax laws/finance bill 2017. Any action taken by you on the basis of the information contained herein is not intended as on offer or solicitation for the purchase and sales of any schemes of UTI mutual Fund. Please read the full details provided in SID and SIA carefully before taking any decision.

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