Beyond CAGR: How to Actually Evaluate a PMS or Mutual Fund

The Metrics That Matter, the Ones That Mislead, and the One Most Investors Have Never Heard Of

The CAGR Trap: Why the Most Popular Metric Is Also the Most Misleading

Ask any investor how they evaluate a mutual fund or PMS, and the first answer is almost always the same: "What’s the CAGR?"

It is the most quoted, most compared, and most dangerously incomplete metric in Indian investing. A strategy that returned 45% in year one and -15% in year two has a very different risk profile from one that returned 14% both years — yet their 2-year CAGRs might look nearly identical. CAGR tells you where you ended up. It tells you nothing about the journey.

This matters because in real life, investors do not experience returns in a vacuum. They experience drawdowns, volatility, sleepless nights, and the constant temptation to exit at exactly the wrong time. A fund that compounds at 16% with minimal drama will almost certainly build more real-world wealth than one that swings between 40% and -20%, because the second investor is far more likely to panic and sell at the bottom.

If you are investing Rs 50 lakh or more in a PMS or evaluating a mutual fund for your core portfolio, you owe it to yourself to look beyond the headline number. What follows is a practitioner’s guide to the metrics that actually matter — including several that SEBI now mandates in PMS factsheets, and one that most investors have never encountered but that we believe is the single most powerful measure of investment quality.

The Familiar Metrics: What They Tell You (and What They Don’t)

1. CAGR (Compound Annual Growth Rate)

What it measures: The annualised return over a specific period, smoothing out year-to-year variation.

Why it’s useful: It gives you a single number to compare returns across different time periods and strategies. SEBI mandates that PMS providers disclose performance using the Time Weighted Rate of Return (TWRR) method, which is a more accurate version of the same concept.

Why it’s not enough: CAGR hides volatility. A fund that went 50%, -30%, 40%, -20% and a fund that went 8%, 9%, 8%, 9% might show similar CAGRs over four years. But only one of them would let you sleep at night. More importantly, only one of them would keep you invested long enough to actually earn those returns.

2. Volatility (Standard Deviation)

What it measures: How much returns deviate from their average. High standard deviation means the ride is bumpy; low means it is smooth.

Why it matters: Volatility is the denominator in almost every risk-adjusted metric. Two funds with the same CAGR but different volatility are fundamentally different investments. The one with lower volatility delivered the same return with less risk — which means it is likely more repeatable and more sustainable.

The caveat: Volatility treats upside and downside movement equally. A fund that shoots up 10% in a month is penalised the same as one that drops 10%. This is why more sophisticated metrics separate the two.

3. Sharpe Ratio

What it measures: Return earned per unit of total risk (volatility), after subtracting the risk-free rate.

Formula: (Portfolio Return – Risk-Free Rate) / Standard Deviation of Portfolio

How to read it: A Sharpe ratio above 1.0 is generally considered good. Above 1.5 is excellent. Below 0.5 suggests the returns do not adequately compensate for the risk taken.

Limitation: It assumes returns are normally distributed (they rarely are in equity markets) and penalises upside volatility equally with downside — which is why the Sortino ratio was invented.

The Advanced Metrics: What Sophisticated Investors Actually Look At

4. Sortino Ratio

What it measures: Similar to Sharpe, but only penalises downside volatility. It answers a better question: how much return are you earning per unit of bad risk?

Formula: (Portfolio Return – Risk-Free Rate) / Downside Deviation

Why it’s better than Sharpe: If a fund is volatile because it occasionally shoots up significantly, that is not “risk” in any meaningful sense — it is a bonus. Sortino captures this distinction. A fund with a lower Sharpe but higher Sortino than a peer is telling you that its volatility comes from the upside, not the downside. That is exactly the asymmetry you want.

5. Maximum Drawdown (MDD)

What it measures: The largest peak-to-trough decline in portfolio value during a specific period. If your portfolio went from Rs 1 crore to Rs 65 lakhs before recovering, your MDD was -35%.

Why this is critical: MDD is arguably the most visceral metric. It answers the question every investor secretly wants answered: "In the worst-case scenario, how much could I lose before things turn around?" A fund with a lower CAGR but significantly lower MDD may be the superior choice for most investors, because they will actually stay invested through the downturn.

6. MDD Recovery Days

What it measures: How long it took the portfolio to recover from its maximum drawdown and regain the previous peak.

Why it matters: A 25% drawdown that recovers in 3 months is a very different experience from one that takes 18 months. Recovery time is a proxy for the strategy’s resilience and its ability to capitalise on market rebounds. SEBI’s disclosure norms encourage PMS providers to present drawdown data alongside performance, precisely because returns without risk context are misleading.

7. Upside Capture Ratio

What it measures: How much of the benchmark’s positive returns the fund captures. An upside capture of 110% means when the Nifty goes up 10%, the fund tends to go up 11%.

What to look for: Above 100% is good — it means the fund outperforms during bull markets. But this must always be read alongside downside capture.

8. Downside Capture Ratio

What it measures: How much of the benchmark’s losses the fund captures. A downside capture of 75% means when the Nifty falls 10%, the fund typically falls only 7.5%.

The ideal combination: Upside capture above 100% AND downside capture below 100%. This means the fund makes more than the market in good times and loses less in bad times. Very few strategies achieve this consistently — those that do deserve your attention.

9. Information Ratio

What it measures: The consistency of a fund’s outperformance over its benchmark, relative to the volatility of that outperformance (tracking error).

Formula: (Portfolio Return – Benchmark Return) / Tracking Error

Why it’s valuable: A high information ratio means the fund doesn’t just beat the benchmark — it beats it consistently. An IR above 0.5 is solid; above 1.0 is exceptional. This metric is the gold standard among institutional allocators for evaluating active fund managers.

10. Portfolio Turnover

What it measures: How frequently the portfolio’s holdings are replaced over a period. A turnover of 100% means the entire portfolio was replaced once during the year.

Why it matters: High turnover generates higher transaction costs, higher tax liability (short-term capital gains), and often signals a reactive rather than systematic strategy. In PMS, where ticket sizes are large, the tax impact of frequent churning can meaningfully erode net returns. A quant strategy should have deliberate, rules-driven turnover — not frantic buying and selling based on daily market noise.

The Complete Metrics Dashboard: Your Evaluation Cheat Sheet

Key Performance Metrics for Evaluating PMS and Mutual Funds

The Metric Most Investors Have Never Used: Rolling Return Analysis

Everything discussed so far is useful. But if you could look at only one metric to evaluate a fund or PMS strategy, we would argue it should be this: rolling return analysis.

And yet, in our experience, fewer than 5% of Indian investors have ever looked at rolling returns before making an investment decision. Here is why it matters, and how to use it.

What Are Rolling Returns?

A rolling return calculates the return over a fixed window — say 3 years — starting from every single day (or month) in the strategy’s history, and then rolling that window forward by one day (or month) at a time.

For example, if a fund has a 10-year track record, a 3-year rolling return analysis would calculate:

• The return from Day 1 to Day 1,095 (Year 1 to Year 3)
• The return from Day 2 to Day 1,096
• The return from Day 3 to Day 1,097
• …and so on, for every possible 3-year window in the fund’s history

This produces hundreds or thousands of data points, each representing a unique 3-year investment experience. Instead of a single CAGR number, you now have an entire distribution of returns — a complete picture of what it actually felt like to be invested in this fund over every possible 3-year period.

Why 3-Year Rolling Returns Matter More Than CAGR

Consider two PMS strategies, both showing a 5-year CAGR of 18%:

Strategy A: Rolling 3-year return analysis shows returns ranging from 8% to 32%, with a median of 17%. In 78% of all rolling 3-year windows, it outperformed its benchmark.

Strategy B: Rolling 3-year return analysis shows returns ranging from -5% to 55%, with a median of 16%. In only 52% of all rolling 3-year windows, it outperformed its benchmark.

Both have similar CAGRs. But Strategy A delivered consistent, reliable outperformance across virtually every 3-year period an investor could have experienced. Strategy B swung wildly — sometimes brilliantly, sometimes terribly — and only beat the benchmark about half the time. Which would you trust with your capital?

The key insight: When you compare the median of a fund’s rolling 3-year returns against the median of the benchmark’s rolling 3-year returns over the same period, you strip away the noise of individual years and see the strategy’s true underlying edge. Pair this with the fund’s volatility, and you have the two most powerful dimensions of investment quality: how much outperformance the strategy delivers, and how reliably it does so.

The Grey Sky Capital Approach to Rolling Returns

At Grey Sky Capital, rolling 3-year return analysis is not just one metric among many. It is the primary lens through which we evaluate, rank, and prioritise our models.

Specifically, we look at two things:

1. Median rolling 3-year return vs. benchmark median: This tells us whether the model has a genuine, persistent edge over the index — not in one cherry-picked period, but across every possible 3-year window in our backtested and live history.

2. Outperformance frequency: Of all the rolling 3-year observations, what percentage show returns above the benchmark? We express this as a simple ratio: if a model outperforms in 820 out of 1,000 rolling 3-year windows, its outperformance frequency is 82%.

A model with a high median rolling return AND a high outperformance frequency is a model we trust. It has demonstrated not just an edge, but a consistent, repeatable edge across diverse market conditions.

Important caveat: Rolling return analysis requires a meaningful track record. A fund with only 2 years of live performance cannot produce 3-year rolling returns. This is precisely why newer strategies — including ours — rely on rigorous backtesting, with careful attention to survivorship bias, look-ahead bias, and transaction cost modelling, to build confidence in the model’s behaviour before live deployment. We are transparent about where our backtested results end and live results begin.

Putting It All Together: A Practical Framework

Here is a step-by-step framework for evaluating any PMS or mutual fund, whether you are investing Rs 50 lakh or Rs 5 crore:

1. Start with CAGR, but don’t stop there. Use it as a screening filter, not a decision-maker. Compare it against the benchmark over 3+ year periods using TWRR (as SEBI mandates).
2. Check risk-adjusted returns. Look at Sharpe and Sortino ratios. If Sortino is significantly higher than Sharpe, the fund’s volatility is coming from the upside — a good sign.
3. Examine the downside. Maximum drawdown and recovery days tell you what the worst period felt like. Can you live with that experience? Be honest with yourself.
4. Demand capture ratios. Upside capture > 100% and downside capture < 100% is the holy grail. Most funds fail this test.
5. Ask for rolling return analysis. If the fund manager cannot or will not provide 3-year rolling return data, ask yourself why. What is the median? What percentage of windows beat the benchmark? This is the single most revealing question you can ask.
6. Watch the turnover. Excessive churn is a hidden tax. Understand why positions are being changed and at what frequency.
7. Look at the Information Ratio. This separates consistent alpha generators from lucky one-hit wonders. Above 0.5 is good. Above 1.0 is rare and excellent.

The Bottom Line

The Indian investment industry has trained investors to chase CAGR. Buy the fund with the highest return last year. Pick the PMS with the best 3-year number. Compare based on a single data point and hope for the best.

This approach is not investing. It is gambling with a spreadsheet.

Genuine investment evaluation requires you to understand not just where a strategy ended up, but how it got there. Was the path smooth or volatile? Did it protect capital in bad times? Was its outperformance consistent or concentrated in one lucky period? Does the strategy have a repeatable edge, or did the manager just happen to be in the right stocks at the right time?

Rolling return analysis, paired with risk-adjusted metrics like Sortino, drawdown analysis, and capture ratios, gives you the tools to answer these questions. And in our experience, the answers often look very different from what the headline CAGR would suggest.

The best investment is not the one that gives you the highest return in a single year. It is the one that gives you a return you can trust, in a process you can understand, over a timeframe that actually matters.

Disclaimer

This article is for informational and educational purposes only and does not constitute investment advice or a recommendation. Past performance, including backtested performance, is not indicative of future results. All investments carry risk including loss of principal. Grey Sky Capital Private Limited is a SEBI-registered Portfolio Manager (Registration No. INP000009694). Investors should consult their financial advisor before making investment decisions. The metrics discussed herein are illustrative and should not be the sole basis for investment decisions. SEBI mandates performance disclosure using Time Weighted Rate of Return (TWRR). Please refer to the SEBI Master Circular for Portfolio Managers for complete regulatory disclosure requirements.

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