While relative returns compared to benchmarks or peers grab more attention, evaluating absolute returns is crucial to assessing a mutual fund’s performance. Let’s understand what absolute returns are and how they can help investors gauge average mutual fund returns and make better investment decisions.
What is a mutual fund?
A mutual fund is a professionally managed investment scheme that pools money from multiple investors and invests it across different securities like stocks, bonds, and other assets. This allows small investors to gain exposure to a diversified portfolio managed by investment experts.
What are absolute returns?
Simply put, absolute returns refer to the actual return generated by a mutual fund scheme over a specified period of time, without relating it to any benchmark. It factors in only the net asset value (NAV) appreciation and income/dividend payouts during that period to calculate the total return. For example, if a debt fund generated a return of 8% annually over 3 years through interest payouts and capital appreciation, its absolute return for the period would be 8% per year or around 26% in total for 3 years (1.08^3 – 1).
This return has been achieved independently without considering how it fares against other funds or debt market indices. Absolute returns thus quantify the stand-alone performance generated for investors in rupee terms.
Why are absolute returns important?
Absolute returns are crucial because they quantify the actual profit generated by a mutual fund rather than just returns relative to a benchmark. By looking at the appreciation in NAV and income/dividend distributed over time, absolute returns clearly show the fund’s ability to grow an investor’s wealth portfolio. This is a true measure of the fund’s performance without factoring in how other similar funds have performed.
Evaluating absolute returns is also important because an investor’s key financial objectives like saving for retirement, higher education, or capital appreciation are dependent on achieving target returns in absolute amounts. One needs to know if a fund can generate 12% annual absolute returns rather than if it has outperformed its benchmark by 3%. Absolute returns directly indicate if a fund’s performance is sufficient to meet such pre-defined monetary goals.
Even the top performing funds on a relative basis may show lackluster absolute returns during difficult market conditions if the underlying benchmark also plunges sharply during that period. Relying only on relative returns can mislead investors into believing a fund is performing well, whereas assessing absolute numbers provides the whole picture of actual returns delivered.
Fund management expenses can only be recovered from a long-term investment perspective if the absolute returns generated by the mutual fund, after considering the net annual fees, are positive. Assessing absolute returns helps investors understand if the total profits from the fund over years outweigh the total fees deducted over the same period.
Conclusion
Understanding the concept of absolute returns is key to evaluating a mutual fund’s true performance and suitability for an investor’s goals. While relative returns garner more attention, absolute returns indicate the actual profits generated by a fund. This is vital considering many investors usean online mutual fund investment calculator to estimate long-term returns based on a fund’s historical absolute return figures.
