Every investor is keen to know what return will he get from his investment. Return from an investment for a normal investor would mean the difference between the amount of investment made and the amount of money he gets when he exits an investment product. But calculating returns is not that simple. Many mutual fund investors do not seem to have a clear understanding of a fund’s total return. The relationships between a fund’s net asset value (NAV), yield (income) and capital gains distributions can be confusing. One has to consider the duration of investment, charges, income payouts in the form of dividends and interest etc. to know the exact and fair return from a mutual fund scheme. So, it is essential to know the various measures of return.

1. SIMPLE RETURN

The NAV of a mutual fund scheme reflects its performance. The simple return of a mutual fund scheme can be calculated with the help of NAV in the following manner.

Simple Return = (Current NAV of the Scheme – Initial NAV )/  (Initial NAV )X 100

Example: Suppose you invested in a scheme when it’s NAV was Rs 12 and it has not declared a dividend. Later, you found that the NAV has grown to Rs 15. How much is your return?

Simple return = (15-12)/12 x 100 = 25%

simple return is simply the change in the value of an investment over a period of time.

If the scheme had declared a dividend of Rs 0.30 per unit, then that aspect of the return is not captured in the above calculation. Without the dividend payment, the NAV might have been Rs 15.3 instead of Rs 15. In that case, the simple return would have been {(Rs 15.3 – Rs 12) ÷ Rs 12} X 100 i.e. 27.5%.

This simplistic approach of adding back the dividend component in the scheme return is called total return.

It is a superior approach to calculate the simple return instead of total return for growth schemes of the mutual funds in order to have a fair view of the returns.

2. ANNUALISED RETURN

It refers to the calculation of return for a year. In simple words, it would be a yearly return. Simple return could be for 2 months or even for 10 months. Annualized return helps in the comparison between two or more funds.

Example: if a mutual fund scheme gives 5% return earned over 2 months, then the annualized return would be (5% ÷ 2) X 12 i.e. 30%. The same 5% return earned over 6 months translates into an annualized return of (5% ÷ 6) X 12 i.e. 10%.

While announcing returns for periods shorter than a year, liquid schemes are allowed to use annualized returns unless they do not mislead.

3. COMPOUNDING ANNUALISED GROWTH RATE (CAGR)

This is the SEBI-prescribed method of disclosing returns, by all schemes for time periods longer than a year. It is better to use CAGR in order to announce the returns if the period is more than a year. It shows that what return the investment would have been earned if the scheme gives steady returns during a period of time.

#=no. of years

Example: if an investor has purchased 100 units of a mutual fund at a NAV of Rs 20. And now the NAV after 3 years has turned to Rs 40. What would be the return for the past 3 years?

CAGR = (((40/20)^(1/3))-1) *100 = 25.99%

4. LOAD ADJUSTED RETURN

This return takes into account the entry as well as exit load while calculating returns.

Example, the CAGR was calculated with the closing NAV as Rs 40. However, if an exit load of 1% was applicable, then you will receive only 99% of Rs 40 i.e. Rs 39.6 on re-purchase. Thus, your return as an investor would be lower than the scheme returns.

Similarly, if the original investment had suffered an entry load of 2%, you would have bought the units at 102% of Rs20 i.e. Rs 20.40. This would have brought down the returns. (Fortunately for the investor, entry load is no longer permitted).

So the return would be calculated considering the entry load and exit load. But today only exit load is applicable and the return is calculated by taking into account the exit load.

5. XIRR

This approach is used when the dividends are to be considered when calculating the returns.

Example: Mr A makes an investment of Rs 1200 in a mutual fund scheme by purchasing 120 units at a NAV of Rs.12 on 1/1/11. On 2/4/11 and 6/4/12 he gets a dividend of Rs 1 per unit. And the NAV on 6/4/12 is Rs 13. So what will be the return of the mutual fund on 6/4/12?

While calculating XIRR outflows (investment) from the investor have to be shown as negative cash flows, while inflows (dividend, repurchase) and a closing value for the investor have to be shown as positive cash flows. There is a direct formula for XIRR in MS Excel.

MEASURES OF RISK

While choosing a mutual fund return is not the only criteria, one should check the risk-return, liquidity etc. also. There are two measures of risk that are used in various risk-adjusted return frameworks – standard deviation and beta. The standard deviation can be used for all scheme types but it would be better to use the beta for diversified equity schemes.

1. Standard deviation

Standard deviation (SD) measures the volatility of the fund’s returns in relation to its average. It tells you how much the fund’s return can deviate from the historical mean return of the scheme. If a fund has a 12% average rate of return and a standard deviation of 4%, its return will range from 8-16%.

Example: NAVs of five weeks are given and the weekly returns are also given. Weekly returns can be calculated with the help of simple return formula. Now, with the help of weekly returns, the standard deviation can be calculated in the following manner.

Higher the standard deviation, higher would be the risk associated with the mutual fund scheme.

2. BETA

It measures a fund’s volatility compared to that of a benchmark. It tells you how much a fund’s performance would swing compared to a benchmark.

Beta can be calculated with the help of function ‘SLOPE’ in MS Excel, as shown in the following table with Sensex as the benchmark:

In the above example, the beta is .398 i.e. it is less than 1. And it means that it is less risky than the benchmark (Sensex).

Beta = 1: This happens when the stock price movement is same as that of the market.

Beta > 1: Beta exceeds one when the stock price movement surpasses market movement.

Beta < 1: This happens when the stock price moves less in comparison of markets