Friday, Nov 8 2024
Source/Contribution by : NJ Publications

As investors, we are very cautious about the value of our hard-earned money. So, we meticulously evaluate the performance of mutual funds using various metrics before making investment decisions. One of the most common methods used by mutual fund investors to evaluate performance is historical returns.

While there are several ways to calculate historical returns of an investment, two of the most common metrics are Point to Point Returns and Rolling Returns. Without a clear understanding of what these returns reveal about an investment product, it can be difficult to select the best investment options.

In this article, we will explain each method, outline their differences, and provide guidance on how to interpret these returns to optimize your investment choices.

Point to Point Returns:

Point-to-Point Returns, measure the return of an investment from a specific starting point to an ending point. It shows performance at a particular point in time and not performance over a period of time. It is simple and easy to calculate.

Example:

Limitations:

Drawing conclusions from looking merely at these returns would be misleading as the representation does not show a true picture of events. For example, if two funds have similar returns, you cannot find which one is the more volatile fund. Let’s understand with an illustration.

Suppose, both Fund A and Fund B have delivered a 10% absolute return over the past 5 years. This snapshot looks great for both! Point to point returns don't show us the journey within those 5 years. Maybe Fund A had a steady, consistent 10% growth year-over-year for the past 5 years. While Fund B had a Fantastic first year with a 50% return, followed by 4 years of flat or even slightly negative returns, averaging out to 10% over 5 years. Here, Fund B could be a riskier option with a higher chance of volatility. But only looking at the 10% point to point return would never give you any idea about the volatility in both the fund’s past performance. Trailing returns wouldn't tell us the difference between these two scenarios. They only show the end result, not the path taken to get there.

- The point to point return of funds can paint a very different picture of performance. They are influenced either by what happened on the start date or on the end date. A scheme might have underperformed throughout the period, however if the scheme out performs in the last few days, the overall performance might improve and vice versa.

For instance, let's assume that an investment in a mutual fund scheme was made 3 years ago. Between then and now, the scheme NAV has more than doubled. But for the first two years, it generated lackluster returns compared to peer funds. The scheme outperformed in the last one year. Computing the 1 year point-to-point return would show a bright picture which would be misleading.

The way to avoid being influenced in this manner is to look at returns over a longer period. Therefore, rolling returns must be referred to take into account market cycles and present a more realistic picture.

Rolling Returns:

Rolling returns are the annualized average returns for a period such as 1 year, 3 years, 5 years, etc. calculated at regular intervals. In other words, a rolling return takes the average of all return points for the chosen period.

For instance, a 3-year rolling return would calculate the annualized return for every three-year period within the overall investment time frame.

Rolling returns can be calculated daily, weekly, monthly or yearly.

Example:

Suppose we want to see a 5-year rolling return of a fund over the period of 15 years between 31 July 2009 to 31 July 2024. So, calculate the 5-year return on each day during this period i.e. the 5-year return as on 31st July 2009, 1st August 2009, and so on till 31st July 2024. It will show you a spread of returns had you invested on any day during this period.

With a higher number of observations, Rolling returns provide a more comprehensive view of the fund's performance across different market conditions. It helps in identifying the fund's consistency and ability to weather various market cycles.

One of the limitations of rolling return is that it is more complex to calculate and understand compared to point-to-point returns.

Conclusion

Both point-to-point returns and rolling returns provide valuable insights into investment performance, each serving a different purpose. Point-to-point returns offer a straightforward view of performance between two specific dates, ideal for short-term evaluations and comparisons. In contrast, rolling returns deliver a more comprehensive perspective, capturing performance consistency and variability over overlapping periods, making it useful for long-term assessments.

Investors should consider both metrics to gain a fuller understanding of their investments and make more informed decisions. By leveraging these performance measures, you can better evaluate your investment’s historical performance and its potential for future returns.

NOTE:

Both rolling returns and point-to-point returns rely on historical data. Past performance is not indicative of future results. While these metrics offer valuable insights, they should be used in conjunction with other factors like the fund's investment objective, portfolio composition, and expense ratio when making investment decisions.

Friday, Oct 04 2024
Source/Contribution by : NJ Publications

Retail Investor's Dilemma: Should You Dive into Futures & Options Trading?

F&O trading is often romanticized as a quick path to riches, fueled by sensational stories of overnight gains and social media hype. However, the reality is far more complex. There's no guaranteed formula for success in F&O trading, and the risks involved can be substantial. Market conditions, volatility, and individual trading decisions all play a crucial role in determining outcomes.

F&O trading can be a complex and risky endeavor, and it's generally not recommended for retail investors who lack a deep understanding of the underlying concepts and strategies.

A recent study by SEBI found that a staggering nine out of ten individual traders lost money in the F&O segment during FY24. Specifically, the report indicated that 91.1% of individual traders-approximately 73 lakh-incurred losses. This study follows a SEBI report from January 2023, which showed that 89% of individual F&O traders lost money in FY22.

Over the period from FY22 to FY24, an estimated 1.13 crore unique individual traders collectively lost ₹1.81 lakh crore in F&O trading, with FY24 alone accounting for ₹75,000 crore in net losses. Only 7.2% of individual F&O traders reported profits over these three years, and a mere 1% earned more than ₹1 lakh after considering transaction costs.

The addictive nature of derivatives trading is evident in the fact that over 75% of loss-making traders continued to participate even after incurring significant losses in the past two years.

Data from SEBI indicates that the monthly notional value of derivatives traded reached ₹10,923 lakh crore ($130.13 trillion) in August, making it the highest globally. A significant portion of this activity involves options contracts tied to major stock indices like the BSE Sensex and NSE Nifty 50. The volumes of index options on the National Stock Exchange skyrocketed nearly 13-fold, from ₹10.8 lakh crore in FY20 to ₹138 lakh crore in FY24.

Demographically, the report highlighted that half of the F&O traders in FY24 hailed from just four states: Maharashtra (18.8 lakh or 21.7%), Gujarat (10.1 lakh or 11.6%), Uttar Pradesh (9.3 lakh or 10.7%), and Rajasthan (5.4 lakh or 6.2%).

A growing concern is the increasing number of young investors venturing into the high-risk, high-reward world of futures and options trading. As per SEBI report, the participation of traders under 30 years old rose to 43% in FY24, up from 31% in FY23. However, 93% of these young traders reported losses—higher than the overall loss rate of 91.1% in FY24. Additionally, over 75% of individual traders (65.4 lakh) earned less than ₹5 lakh annually in FY24.

The F&O market's exponential growth can be attributed to increased market awareness, better access to financial products, and the influence of "fin-fluencers" on social media platforms. This has led to heightened scrutiny from SEBI, which noted that the rise in derivatives trading had

become a macroeconomic concern as household savings were being diverted toward speculation rather than capital formation.

In response, SEBI has proposed several measures aimed at enhancing investor protection and market stability:

1. Increased contract sizes:

   The initial recommendation is to raise the contract value from ₹5-10 lakh to ₹15-20 lakh, with a further increase to ₹20-30 lakh after six months. This increase aims to ensure that investors take on suitable risks while participating in the derivatives market.

2. Higher margin requirements:

   The upfront margin for sellers will be increased to protect investors from extreme market volatility, especially during high-volume trading sessions.

3. Reduction of weekly expiries:

   SEBI plans to reduce the number of weekly expiries from five to just one per exchange, limiting exchanges to six weekly contracts monthly. This aims to curb speculative trading and mitigate the risks of uncovered options selling.

4. Removal of calendar spread benefits:

   The practice of using calendar spreads—offsetting positions across different expiries—will be eliminated for contracts expiring on the same day, reducing speculative trading on expiry days.

5. Intraday monitoring of position limits:

   Starting April 1, 2025, stock exchanges will implement intraday monitoring of position limits for equity index derivatives to ensure that participants do not exceed set limits during trading sessions.

6. Upfront collection of premiums:

   From February 1, 2025, brokers will be required to collect option premiums upfront, discouraging excessive intraday leverage and ensuring investors have sufficient collateral.

These regulatory changes are particularly significant for retail investors who often engage in derivatives trading. Analysts believe these measures may help stabilize the market by curbing high-frequency trading and speculative behavior. SEBI's recent initiatives reflect a commitment to protecting small investors and upholding market integrity.

Final Thoughts

The misconception that F&O trading can lead to overnight wealth is not only unrealistic but also dangerous. It fosters a mindset that encourages reckless trading and can lead to substantial financial losses. SEBI's findings reveal that individual traders in the F&O market suffered cumulative losses of ₹1.8 lakh crore over the past three years. Despite rising retail participation—especially among younger traders and those in B30 cities—most individuals faced significant losses.

Retail investors should carefully evaluate their financial needs, risk tolerance, and knowledge level before venturing into this complex market. Mutual funds and equity investments may not offer the thrill of short-term gains, but they can be your secret weapon for long-term financial success.

Friday, Sept 13 2024
Source/Contribution by : NJ Publications

The saving-spending Dilemma: Are you saving for a luxurious future while neglecting present needs?

The concept of saving for the future is deeply ingrained in our societal psyche. From a young age, we are taught the virtues of thriftiness and the importance of planning ahead. While these principles are undoubtedly crucial for long-term financial stability, the emphasis on saving for the future can sometimes overshadow the significance of enjoying the present moment. The dream vacation is postponed, dining at beloved restaurants becomes a rare indulgence, and purchases that could improve daily life are deferred—all in the pursuit of securing a distant future through savings.

This is the battle that all of us face between living the life of choice and envisioning a stable monetary capacity for one’s future.

Savings are essential but it does not mean that you should sacrifice on each and everything, otherwise money will lose its value in your life. It also does not imply that you start enjoying the present without giving thought to the future. There are negative effects on both sides: Savers often end up with ‘regrets’ and spenders with ‘financial problems’ in the future. What is required is - keeping the balance.

A balance that allows for the fulfillment of current needs and desires without compromising future security. Neither merely saving nor merely spending is the right way. Saving money should be integrated as a positive and habitual aspect of life, rather than a source of stress.

Famous writer, Samuel Johnson, rightly quotes - “A Man Who Both Spends And Saves Money Is The Happiest Man, Because He Has Both Enjoyments.”

Let’s explore some tips on how to find the right balance between enjoying your money and long-term investing, so that you can make the most of your financial resources both now and in the future.

1. Create a Budget: Start by outlining income, fixed expenses, and discretionary spending. Allocate a portion of income towards savings and investments while earmarking funds for daily needs and occasional indulgences. Sticking to your budget by not spending impulsively might help you stay a disciplined investor.

2. Need Assessment: Establish short-term and long-term financial needs. This could include saving for emergencies, retirement, education, or a major purchase. Clear objectives provide clarity and motivation for both saving and spending decisions.

3. Prioritize Needs Over Wants: Differentiate between essential expenses (needs) and discretionary spending (wants). Ensure that essential needs are addressed before allocating funds to discretionary wants, thereby preserving financial discipline without compromising on enjoyment. Make a checklist of your needs priority wise. Having a checklist may help you spend and save wisely.

4. Develop an Investment Plan: Once you have defined your needs and assessed your risk tolerance, develop an investment plan that aligns with your needs and risk tolerance. Your investment plan should include asset allocation, diversification, and a timeline for achieving your needs. Aligning your investments with your financial needs and consistently monitoring them will provide you with peace of mind, reducing concerns about market fluctuations and uncertainties ahead.

5. Seek Expert Help: Whenever you find it challenging to plan for your finances, it may be preferred to get in touch with the experts and seek their advice. Consult an advisor and discuss your goals with them to draw a holistic financial plan for achieving those goals. A piece of expert advice can guide you on the right path.

Conclusion:

While saving for the future is prudent and necessary, it is equally important to enjoy the present moment and prioritize current needs. By striking a harmonious balance between saving and spending, individuals can cultivate financial security without sacrificing the richness of everyday life. Ultimately, mastering this dilemma entails not only planning for a luxurious future but also cherishing the journey towards it.