Imagine two friends visit Delhi. One goes in May and returns complaining about the unbearable heat. The other visits in December, raving about the pleasant winter chill. Both experiences are accurate yet completely contradictory, and neither can prepare you for what to expect if you visit the city at random.
Investing works in much the same way. Your returns depend on when you ‘visited’ the stock or fund. If two people start and end at different points, their experiences will be completely different, even if they both have identical investments.
Why portfolio-based judgements fail
When you compare the returns of one fund in your portfolio against another’s, you’re using your own investment timeline as the benchmark. If the investment dates differ, one scheme could look better or worse simply because of when you invested in it. In fact, within your own portfolio, or when comparing your holdings with those of a family member, you might find that the same fund, with the same manager and holdings, yielded divergent returns driven entirely by when the investment was made.
Also, two funds can have very different market-cap compositions; one may lean heavily on large-cap stocks while another could have higher exposure to mid- and small-cap companies. Since these segments behave differently across cycles, comparing their short-term performance directly within your portfolio can lead to incorrect conclusions.
The problem with point-to-point comparisons
When investors review their portfolio, they might find that one or two schemes appear to underperform in comparison to the others and conclude that these funds “aren’t working”. But the real culprit is often starting-point bias.
Take this real example. If you invested ₹1,00,000 in a liquid fund on 23 March 2010, by 23 March 2020 you’d have ₹2,15,439, with an annualised return of 7.98% over the 10 years. The Nifty 50 TRI, over the same 10 years, delivered a 5.13% annualised return, growing to ₹1,64,979.
One might examine this data point in isolation and infer that over 10 years, liquid funds yield a higher return than the Nifty. But is this really true? Of course not. This shows how choosing specific start and end dates can lead to incorrect conclusions. In most other 10-year windows, equities have comfortably outperformed liquid funds.
The case for rolling returns
Assessing a scheme should always be an independent exercise, separate from your personal experience. To mitigate the starting-point bias in a portfolio, analysts use rolling returns.
Rolling returns measure an investment’s performance over multiple, overlapping periods, providing a comprehensive view of its consistency and performance across different market cycles. Daily rolling one-year returns, for instance, calculate an investment’s performance over a 365-day period, starting each new calculation one day after the previous one.
Suppose you calculate one-year rolling returns for a fund from 2010 to 2020. You are effectively measuring how the fund performed between 1 Jan 2010 and 1 Jan 2011, then 2 Jan 2010 and 2 Jan 2011, and so on, until 2019 to 2020 — and then analysing all those observations.
Key advantages of using rolling returns
Removes starting-point bias: Because they consider every possible start date, rolling returns to reduce the possibility of luck influencing the returns.
- Shows consistency: You can see how often the fund has beaten its benchmark or peers with rolling returns. If a fund delivered above-benchmark returns in 80% of the three-year rolling periods, its returns are from sustained performance, not random spikes.
- Highlights volatility: Rolling-return charts often show the difference between the best and worst returns over various periods. This helps investors gauge how bumpy or stable the ride has been.
- Helps set realistic expectations: Instead of anchoring expectations to a single return number, rolling data shows the range of possible outcomes, mentally preparing investors for ups and downs.
In our Delhi analogy above, rolling returns are the equivalent of both friends visiting in May and December but staying there for a whole year. This helps them experience the full cycle and provides a complete and accurate picture of the weather in Delhi.
For investors seeking more insights, working with a qualified advisor could help bring structure to this evaluation and prevent emotionally driven decisions.
Saurabh Mittal is a registered investment advisor and founder of Circle Wealth Advisors Pvt. Ltd. Views are personal.
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