# What is the difference between trailing returns and rolling returns?

Trailing returns are about knowing historic returns of a stock or a fund. In trailing returns, you just calculate point-to-point returns and then annualize it.

Aug 05, 2018 10:08 IST India Infoline News Service

Before we get into the nuances of trailing returns and rolling returns, let us look at a very practical example. This question was first posed by Nassim Nicholas Taleb in his acclaimed book “The Black Swan”. Would you confidently walk across river that had an average depth of 4½ feet? The depth of the river is OK if you are a strong 6-feet person, but the problem arises with the word “average”. What it means is that in some places the river could be much shallower and in some places the river could be much deeper. Effectively, if the river has a depth range of 3 feet – 8 feet, it only means that in certain places, the river is deep enough to sink you completely. It would have been disastrous for you to cross the river purely based on the average depth. This is the basis for understanding the argument of trailing returns versus rolling returns.

What exactly is trailing returns?
Trailing returns are about knowing historic returns of a stock or a fund. In trailing returns, you just calculate point-to-point returns and then annualize it. It broadly gives you an idea about whether the fund or the stock has created wealth or depleted wealth over a period of say 3 years. Let us look at 4 such funds and evaluate the trailing returns.

 Particulars Fund A Fund B Fund C Fund D Investment Date July 2, 2015 July 2, 2015 July 2, 2015 July 2, 2015 NAV Rs100 Rs100 Rs100 Rs100 Redeemed on July 2, 2018 July 2, 2018 July 2, 2018 July 2, 2018 NAV Rs165 Rs148 Rs139 Rs121 3-year Returns 65% 48% 39% 21% CAGR Returns 18.17% 13.97% 11.61% 6.57%

If you were to look at the above table, your immediate conclusion will be that Fund A is an outperformer and Fund D is a rank underperformer based on annualized returns. But there is a small problem with this calculation. This is a point-to-point return. That means, Fund A may have purely benefited from the timing of the purchase and sale. Probably, if you had bought the fund on August 2, 2015 and sold the fund on July 2, 2018, then Fund A may not have been the best performer. The moral of the story is that the trailing returns are just too dependent on the date of entry and exit. If you purchase a fund based on trailing returns, you may end up with a fund that may have done well on a point-to-point basis, but may not be too consistent. That is where rolling returns have an advantage over trailing returns. Rolling returns give a much better picture of the consistency of the fund as compared to the trailing returns.

How to calculate rolling returns?
Rolling returns go a step further and make the calculation of returns more time dynamic and sensitive. It gives a better picture of your actual returns irrespective of when you invested. The focus here is more on the holding period rather than on the timing of the entry and exit into an investment. To that extent, it is more timing-agnostic and is more useful from an investment and financial planning point of view. But what exactly does rolling returns do?

The task of calculation of rolling returns is done in two ways. Firstly, it decides on the total time period for calculation of returns. Then it works out the interval to be considered. The interval will depend on your time frame. For example, if you are looking at 3 month returns, then daily rolling is required. If you are looking at 1 year returns, then weekly rolling return is fine. But if you are looking at 8-10 year returns, then monthly rolling is fine. Check out the comparison below:

 Rolling Date Fund NAV 3-day Roll Adjusted Value 10-07-2018 100.00 11-07-2018 102.00 12-07-2018 104.00 13-07-2018 102.00 0.020000 1.02 Geometric 14-07-2018 103.00 0.009804 1.01 Mean 15-07-2018 103.50 -0.004808 1.00 0.9992 16-07-2018 101.00 -0.009804 0.99 17-07-2018 102.00 -0.009709 0.99 18-07-2018 102.00 -0.014493 0.99 19-07-2018 101.30 0.002970 1.00 20-07-2018 102.00 0.000000 1.00 Trailing Returns 2.00% Rolling Returns -0.08%

Here we have considered daily rolling returns with an interval of three days. When you calculated the trailing returns on a point-to-point basis, it showed a 2% return, but when you considered the rolling returns, you ended up with negative returns of (-0.08%). That is because trailing returns have ignored all the volatility in between.

3 reasons why rolling returns present an improvement over trailing returns?
1. Firstly, over longer periods of time, rolling returns tend to absorb the vagaries of the market and give you a smooth picture of the fund performance. When you compare mutual funds, you must compare them on rolling returns rather than on trailing returns.
2. If the trailing returns and rolling returns are around similar levels over longer periods of time, then it indicates that the fund has delivered consistent performance and the timing of the entry and exit is not too critical. Such funds can be a good investment vehicle to combine wealth creation with consistency.
3. From a practical standpoint, rolling returns are more workable. That is because investors rarely commit money on a lump sum basis. Most of your investments are in the form of systematic investment plans (SIPs) at regular intervals. In such a situation, rolling returns are more credible.

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