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Returns play a key role in evaluating a <a target="_blank" href="https://mintgenie.livemint.com/news/personal-finance/investors-in-overseas-mutual-funds-see-sharp-fall-in-value-by-21-to-40-percent-from-peak-151655266096429">mutual fund</a>’s performance. Different investors follow varied parameters to judge the performance. Some tend to get impressed with the figures like an investment becoming double in ‘X’ number of years, whereas some prefer metrics like <a target="_blank" href="https://mintgenie.livemint.com/news/personal-finance/these-flexi-cap-funds-posted-as-high-as-17-to-19-percent-in-the-past-five-years-151655207258508">CAGR</a> (Compound Annual Growth Rate).

However, not many are aware of the fact that four times return in 10 years, and 15 per cent CAGR in 10 years mean exactly the same.

So, as a well-meaning investor, you should be aware of most common yardsticks that are used to evaluate the performance of a mutual fund and then use the ones that suit you and are commonly used too.

The simplest parameter to judge a fund's performance is absolute returns which are seen as a true indicator of the fund’s performance.

Absolute Return: This means what a fund has earned over a particular period of time. This is the simplest way to compute returns. For instance, if someone invested ₹one lakh in a fund scheme and received ₹1.5 lakh after two years, it fetched an absolute return of 50 percent.

The absolute value only considers the initial value and current value and not the tenure of the investment. This can be seen as a fair metric only when the investment tenure is less than or equal to one year.

CAGR: Another yardstick is trailing CAGR. This shows the returns after doing the compounding of fund during the tenure of fund. For instance, when a fund gives 60 percent return in four years by growing from ₹one lakh to ₹1.6 lakh, the fund’s CAGR was 12.468 percent.

So, CAGR is another way of computing year-on-year compounding return generated by a scheme. This is one of the most common return metric of mutual fund schemes.

Rolling return: This is seen as a better version of evaluating mutual fund returns since it also incorporates the volatility of the fund. To incorporate the volatility, one can make use of the rolling return metric. Under this method, you will get a number of CAGR returns.

Hence, apart from indicating how high mutual fund returns are, this metric also shows how consistent were these returns.

XIRR metric: (Extended internal rate of return) is the true indicator when investor makes staggered investment in several schemes. This is a good indicator when investment is made through SIPs (systematic investment plans).

When an investor makes investment in multiple tranches then CAGR can't give an accurate single number about the return. This is where XIRR offers a solution. This is a yardstick that gives an annualised return considering all the investment and withdrawals at different intervals.

SIPs are invested at different time intervals and each SIP is invested for a different time period. So, XIRR takes into account the CAGR of all investments and gives a single figure of annualised return.

Comparing with other funds: In an active fund, expense ratio is higher than that of a passive scheme. So, it is vital to know how much extra the fund has delivered in relation to its benchmark index. This is how you calculate relative return of the fund.

Another important factor to pay attention to is the variant of benchmark index. There are essentially two benchmarks: price return index (PRI) and total return index (TRI).

While PRI encapsulates only increase in capital, TRI incorporates returns from dividend as well. So, TRI is seen as a better comparison while evaluating the performance of a mutual fund.

As we saw, there are different metrics to evaluate the performance of mutual funds and which one you would use depends on the tenure, mode of investment, type of fund among other factors.

What are the different ways to evaluate mutual fund's performance? 

There are multiple ways to evaluate the performance of mutual funds such as rolling returns, trailing CAGR, XIRR

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