NISM Series XVII · Chapter 5: Evaluating Fund Performance & Fund Selection

L1 · Foundation

Foundation — Return on investment and the four ways to measure it

The pre-investment checklist an adviser runs before recommending anything; the two components of return and how they combine into total return; absolute rupee return and why percentage return replaces it; annualisation and the three conversion factors; CAGR with its formula and its honest limitation; and XIRR for multiple cash flows, each worked through with the workbook's own numbers.

22 min read · Worth 10% of the paper · Written from pages 167–181 of the official NISM workbook · Updated 18 September 2026

Return on investment and how it is measured

1. The pre-investment checklist

"An investment product is DEFINED BY ITS RETURN AND RISK, LIQUIDITY AND OTHER CHARACTERISTICS. The pre-investment checklist for an investor should EVALUATE THESE FEATURES FOR SUITABILITY BEFORE INCLUDING the investment product in their portfolio."

The questions the workbook says must be answered:

Question	What it tests
⚠️ "What is the TYPE of return that the product generates?"	Periodic return like interest and dividend · Appreciation in the value · A COMBINATION of the two
"Are the returns FIXED OR GUARANTEED?"	Whether the number can move
"Is there a TERM OR PERIOD for which the investment will earn the returns?"	Horizon
"How will the PRINCIPAL INVESTED BE RETURNED to the investor?"	Exit mechanics
"Are the LEVEL OF RETURNS KNOWN AT THE TIME OF INVESTMENT?"	Certainty
⚠️ "Can the capital invested be EASILY ACCESSED if the investor needs the funds?"	Liquidity

And five separate risk questions — note that they are not one question but five:

"Is there a risk of DEFAULT IN RECEIVING THE FIXED PERIODIC INCOME?"
"Is there a risk of NOT RECEIVING THE PRINCIPAL INVESTED?"
"Is there a risk of THE RETURN BEING DIFFERENT FROM WHAT WAS EXPECTED?"
⚠️ "Is there a risk of THE RETURN RECEIVED BEING INSUFFICIENT TO MEET NEEDS?"
⚠️ "Is there a risk of THE RETURN EARNED BEING INADEQUATE TO BEAT THE EFFECTS OF INFLATION?"

The last two are the ones an untrained adviser never asks. A fixed deposit has no default risk and no principal risk — and can still fail an investor completely on questions 4 and 5.

2. What determines a portfolio's risk and return

"The risk and return in a portfolio depends upon THE ASSET CLASS in which the portfolio invests, THE TYPE OF SECURITIES HELD and THE WAY THE PORTFOLIO IS MANAGED."

Portfolio type	What drives risk and return
⚠️ EQUITY	"The extent of DIVERSIFICATION OR CONCENTRATION in the portfolio, the MARKET CAPITALIZATION of the stocks held, the STOCK PICKING STRATEGIES"
⚠️ DEBT	"The CREDIT RATING of securities held and the TENOR of the securities will determine the COUPON INCOME earned and the benefits to the portfolio from AN INCREASE IN VALUE, as well as the RISK OF DEFAULT AND VOLATILITY"

3. The two components of return

The two forms:

✓ "PERIODIC INCOME such as INTEREST OR DIVIDEND"
✓ "GAINS OR LOSSES IN THE VALUE of the investment"

⚠️ On certainty: "Periodic income MAY BE FIXED AND KNOWN IN ADVANCE, LIKE INTEREST ON DEBT SECURITIES. OR IT MAY NOT BE FIXED OR KNOWN at the time of investment, LIKE DIVIDENDS. The gains or losses from an increase or decrease in the value ARE, AGAIN, NOT KNOWN IN ADVANCE."

You do not have to sell to have earned a return. The gain counts from the day the price moves.

The worked example: X invests in a mutual fund at an NAV of Rs 12, receives a dividend of Re 0.80, and one year later the NAV is Rs 12.50.

Component	Amount
Dividend received	Re 0.80
Increase in NAV (12.50 − 12.00)	Re 0.50
⚠️ Total return	⚠️ Rs 1.30

And the same example turned negative: if the NAV at the end of the year is Rs 11:

⚠️ "The total return from the investment is Re −0.20 (Re 0.80 + (−1.00))." The dividend was real and was received; the capital loss of Re 1.00 more than swallowed it.

"Guaranteed but variable" is a genuinely useful phrase. The PPF will certainly pay — but not certainly at the rate you see today.

4. Absolute return

"The ABSOLUTE RETURN IN RUPEES simply COMPARES THE AMOUNT EARNED in the form of interest or dividend and capital gain or loss WITH THE INVESTMENT MADE TO EARN IT."

The workbook's comparison:

	X	Y
Amount invested	Rs 10,000	Rs 5,000
Interest earned	Rs 900	Rs 500
Absolute return	⚠️ Rs 900 — looks better	Rs 500
Percentage return	900 ÷ 10,000 × 100 = 9%	⚠️ 500 ÷ 5,000 × 100 = 10% — actually better

The fix: ⚠️ "The RATE OF RETURN IN PERCENTAGE is calculated as RETURN ON INVESTMENT ÷ ORIGINAL INVESTMENT × 100. THIS CONVERTS ALL INVESTMENTS TO A BASE OF Rs 100 and thus makes it EASY TO COMPARE between investments where the principal invested is different."

"The return earned by Y is HIGHER than that of X, THOUGH IN ABSOLUTE TERMS the return earned by X (Rs 900) is higher."

5. Annualised return

"Just as all principal amounts invested are not the same, similarly THE PERIOD OVER WHICH THE ABSOLUTE RETURNS WERE EARNED MAY NOT BE THE SAME."

"For example, an equity investment may have earned 40 PERCENT OVER A 6-YEAR PERIOD while a fixed deposit may have earned 8.5 PERCENT PER ANNUM. THE RETURNS FROM THE TWO INVESTMENTS CANNOT BE COMPARED because the TIME HORIZON over which they were earned is different."

The three factors — one for each way a period can be stated:

Holding period given in	Factor
⚠️ DAYS	365 ÷ number of days held
⚠️ MONTHS	12 ÷ number of months held
⚠️ YEARS	1 ÷ number of years held

The worked example: "The return from the equity investment can be annualized by MULTIPLYING 40 PERCENT BY THE FACTOR 1/6 for the holding period of 6 years. THE ANNUALIZED RETURN IS 6.67 PERCENT. This is comparable with the 8.5 percent return from the fixed deposit."

⚠️ Look at what happened. A 40% return sounded far better than 8.5%. Annualised, it is 6.67% a year — and the boring fixed deposit actually won. This is the single most common way retail investors are misled, by themselves and by others.

(Note that this simple annualisation ignores compounding — which is exactly why CAGR exists.)

6. Compounded Annual Growth Rate

The worked example: X invests when the NAV is Rs 12.45; three years later it is Rs 16.18.

CAGR = ((16.18 ÷ 12.45) ^ (1/3)) − 1 = 9.12 percent

6.1 The limitation — read this twice

That last sentence is the bridge from this section to the next. CAGR tells you where the journey ended; it says nothing about how rough the road was. Two funds can both post a 9.12% CAGR — one climbing steadily, the other up 40% then down 25% then up 15%. The number is identical. The experience, and the risk, are not.

This is why the chapter moves straight from CAGR to standard deviation, beta and the Sharpe ratio. A return figure alone is an incomplete description of an investment.

7. XIRR

"The XIRR FUNCTION IN MS EXCEL can be used to calculate THE INTERNAL RATE OF RETURN of an investment WITH VOLATILE RETURNS AND MULTIPLE CASH FLOWS TO ACCOUNT FOR."

This is the tool for the real world — where an investor does not put in one lump sum and take it out once, but contributes month after month, as in an SIP or NPS.

The workbook's example: X invests Rs 10,000 every three months in a mutual fund scheme beginning 1 April 2013. The last investment is on 1 January 2016. The value on 31 March 2016 is Rs 1,50,000.

The three inputs required:

⚠️ "CASH OUTFLOWS (investment value at the time of investment)"
⚠️ "CASH INFLOWS (in the form of INCOME — DIVIDENDS OR INTEREST — AND SALE VALUE at the end of the investment term)"
⚠️ "CORRESPONDING DATES"

7.1 Which measure when — the summary

Measure	Use it when	Weakness
Absolute (rupees)	Never, for comparison	⚠️ Ignores the amount invested
Percentage	Comparing different principal amounts	⚠️ Ignores the holding period
Annualised	Comparing different holding periods	⚠️ Ignores compounding
⚠️ CAGR	⚠️ Horizons of OVER ONE YEAR — the accepted measure	⚠️ Says nothing about volatility within the period
⚠️ XIRR	⚠️ Multiple cash flows on different dates	Needs a spreadsheet

Each measure fixes the flaw of the one above it. That is the cleanest way to hold the whole section in your head.

Think of it like this

Two shopkeepers and the wrong kind of bragging

One shopkeeper in the market says he made Rs 900 profit last month; the man next to him made Rs 500. The first one is clearly doing better — until you learn that the first has stock worth Rs 10,000 in his shop and the second only Rs 5,000. Per rupee of capital, the smaller shop is the better business.

This is precisely the workbook's illustration: X invests Rs 10,000 and earns Rs 900; Y invests Rs 5,000 and earns Rs 500. The absolute figures say X won. The percentages say otherwise — 9 percent against 10 percent.

The problem with absolute return is stated in one line: this calculation DOES NOT CONSIDER THE AMOUNT INVESTED to earn the return.

The fix is to put everything on the same footing: the rate of return in percentage is Return on Investment ÷ Original Investment × 100. THIS CONVERTS ALL INVESTMENTS TO A BASE OF Rs 100.

That phrase — converts all investments to a base of Rs 100 — is what every measure in this chapter is doing. Percentage fixes different principal, annualisation fixes different periods, CAGR fixes compounding, XIRR fixes different dates. Each one removes a reason why two numbers could not fairly be compared.

Forty percent that turned out to be six

A man tells you his shop made Rs 40 lakh profit. Impressive — until he mentions it was over six years. That is Rs 6.67 lakh a year, and the neighbour making Rs 8.5 lakh every year is doing better.

The workbook uses exactly this trap: an equity investment that earned 40 percent over a 6-year period against a fixed deposit earning 8.5 percent per annum. The returns from the two investments CANNOT BE COMPARED because the time horizon over which they were earned is different.

Annualise it — 40 percent × (1/6) = 6.67 percent — and the fixed deposit wins.

The three factors are worth memorising as a set because they are simply "one year divided by however long you held it":

Held for days: multiply by 365 ÷ days
Held for months: multiply by 12 ÷ months
Held for years: multiply by 1 ÷ years

This is the most common way retail investors mislead themselves. "My fund has doubled!" means very different things over four years and over fourteen.

The average depth of the river

A river with an average depth of four feet has drowned many people. The average tells you nothing about the ten-foot channel in the middle.

CAGR is that average. It is the average annual rate at which the investment grew from start value to end value — but the workbook is careful to warn: ⚠️ it MAY NOT REPRESENT THE RETURN EARNED IN ANY ONE YEAR SUB-PERIOD during this term.

An investment showing a 9.12% CAGR over three years might have gone +40%, −25%, +15%. Nobody experienced 9.12% in any single year. Only an investor who held for the same holding period as the period of calculation actually earned it; investors who held it for other holding periods, say 1 year, may not have earned the same rate.

And then the sentence that opens the whole next section: ⚠️ THE ACTUAL UNDERLYING RETURN MAY BE VOLATILE, AND THAT VOLATILITY REPRESENTS THE RISK IN THE INVESTMENT.

That is why a return figure never travels alone. Standard deviation measures how deep the middle of the river gets.

The boat that rises higher and the boat that rocks harder

In a harbour, when the tide comes in, every boat rises. But a small light boat rises and falls more with each wave than a heavy barge does. On a calm day the light boat looks livelier; in a storm it is the one that capsizes.

Beta measures exactly this: the extent of volatility in an equity investment attributable to the SYSTEMATIC risks, relative to the volatility in a stock index which has a BETA OF 1.

A stock with a beta of 1.1 does not mean "slightly risky". It means: ⚠️ if the markets went up 10 percent, the price is likely to go up to 11 percent. Similarly, if markets fell 10 percent, the price of this stock is likely to FALL BY 11 PERCENT.

The amplification works in both directions, which is the half people forget when a broker sells them a "high beta" stock in a rising market.

And note what beta does not measure — the company's own problems. Those are unsystematic risks, and unsystematic risks can be reduced or eliminated from a portfolio through DIVERSIFICATION. Beta measures only the part of the risk you cannot diversify away: inflation, political risk, and the like.

The batsman who scored more but faced twice the deliveries

Two batsmen both score in a match — one makes 45, the other 40. The first looks better until you see he took 90 balls and the second took 30. Runs alone is the wrong statistic; runs per ball is the right one.

The Sharpe ratio does the same thing with risk instead of balls: risk adjusted return measures the return that an investment is generating FOR EACH UNIT OF RISK TAKEN.

Sharpe Ratio = (Investment Return − Risk Free Rate of Return) ÷ Standard Deviation

Note that the risk-free rate is subtracted first. You get no credit for the return a treasury bill would have handed you for free — only for the excess return, and only in proportion to the risk you accepted to get it.

The rule that follows: ⚠️ from a group of comparable schemes, investors OUGHT TO PREFER THE SCHEME WITH THE HIGHEST SHARPE RATIO, since it indicates that the scheme is able to GENERATE A HIGHER RETURN FOR EACH UNIT OF RISK TAKEN.

This is why the chapter warns, in the peer-comparison section, that a fund may outperform its peer funds, BUT IT MAY HAVE TAKEN SIGNIFICANTLY HIGHER RISKS to generate the returns. The level of risk may be UNACCEPTABLE to some investors.

Marking the answer sheet against the right paper

A student who scores 70 in a hard physics paper has done better than one who scores 80 in an easy general knowledge test. Marks only mean something against the paper that produced them.

That is what a benchmark does. A 12 percent return from an equity fund MAY SEEM TO BE STRONG. BUT IF THE RETURNS FROM THE BENCHMARK IN THE SAME PERIOD IS 14 PERCENT, then the fund HAS FALLEN SHORT of the goal of an active fund to outdo the benchmark.

But the benchmark must be the right paper: ⚠️ while the Nifty 50 may be a suitable benchmark for a diversified, LARGE CAP fund, IT MAY NOT BE A SUITABLE BENCHMARK FOR A MIDCAP FUND OR A SECTOR FUND SUCH AS A TECHNOLOGY FUND. Similarly Crisil STBEX suits a short-term bond fund, while a gilt fund is better benchmarked against ICICI Securities' Sovereign Bond Indices.

And there is a standard the workbook sets for active management that is worth remembering because it is demanding: an actively managed fund is expected to do better than the benchmark BOTH WHEN MARKETS ARE RISING AND WHEN THEY ARE FALLING — the fund's return is expected to RISE MORE than the index in a rising market and FALL LESS than the index in a declining market.

Beating the index in good times is half the job. Losing less in bad times is the other half.

Key terms in this chapter

Absolute return: The rupee amount earned, compared with the amount invested. On its own it misleads, because it ignores how much capital was needed to earn it.
Accumulation stage investing: Growth, not income, is the objective. A long horizon allows some risk for better returns, equity is suitable, and compounding over the horizon does much of the work.
Aggressive and conservative strategies: An aggressive active portfolio is concentrated, so poor performance by any one security significantly affects the whole; a conservative one is well diversified, so no single holding can do that.
Annualised return: An absolute return converted to a one-year holding period by multiplying by 365 ÷ days, 12 ÷ months or 1 ÷ years. A 40% return over six years annualises to 6.67% a year.
Benchmark: An index used to gauge an asset class's performance over time. It must reflect the features of what it tracks — a market index like the Nifty 50 or Sensex, or a purpose-built one such as Crisil's bond market indices.
Benchmark selection rule: The asset allocation of the benchmark must be representative of the portfolio being evaluated. The Nifty 50 suits a diversified large cap fund but not a mid cap or sector fund; Crisil STBEX suits a short-term bond fund and ICICI Securities' Sovereign Bond Indices a gilt fund.
Beta: A measure of an equity investment's volatility attributable to systematic risk, relative to a stock index which has a beta of 1. A beta of 1.1 means the stock moves 10% more than the index — up AND down.
CAGR: Compounded Annual Growth Rate — ((End Value ÷ Beginning Value)^(1/n)) − 1. The accepted measure for horizons over one year because it accounts for compounding and time value of money, but it does not represent the return in any single sub-period.
Defensive stocks: Stocks of companies whose demand and revenues are less influenced by economic cycles — medicines and health services being the workbook's examples. Diversifying into them offsets cyclical unsystematic risk.
Deposits versus bonds in falling rates: A deposit holder earns only the low interest income, which may not beat inflation. A bondholder earns the low coupon PLUS a capital gain, since falling rates push bond prices up — with the reverse risk when rates rise, sized by the bond's duration.
Distribution stage investing: Low risk debt instruments that can be easily withdrawn to meet the goal — combining income orientation, stable returns and continued protection from inflation.
Guaranteed but variable: The character of an instrument like PPF, where the income is certain to be paid but the rate itself is reset — quarterly, in PPF's case — so the amount is not known in advance.
Investment style: The consistent tilt a manager applies within an asset class — credit quality or interest rate sensitivity in debt, mid-cap or large-cap selection in equity. Mid-caps do better in momentum markets but fall further in declines.
Peer group comparison: Measuring a fund against other similar actively managed funds. Its danger is that a fund may outperform its peers only by taking significantly higher risk, at a level some investors would find unacceptable.
Percentage return: Return on Investment ÷ Original Investment × 100. It converts every investment to a base of Rs 100 so that different principal amounts become comparable.
Pre-tax equivalent: A tax-free rate divided by (1 − tax rate), used to compare a tax-free instrument with a taxable one. At a 20% rate, an 8% tax-free bond is equivalent to a 10% taxable return.
Return on Investment (RoI): Earnings from an investment related to the cost paid to acquire it, made up of periodic income (interest or dividend) plus gains or losses in value. Gains count whether realised by selling or merely notional.
Risk adjusted return: Return measured against the risk taken to earn it, rather than in isolation. It exists because higher risk must be justified by higher returns, and lower returns must come with lower risk.
Sharpe ratio: (Investment Return − Risk Free Rate) ÷ Standard Deviation — the return generated for each unit of risk taken. Among comparable schemes, the highest Sharpe ratio is preferred.
Sources of NPS fund data: NAVs, portfolios and returns are on the pension fund, NPS Trust and CRA websites. Consolidated NAV and return data for every pension fund sits on the NPS Trust website, and a subscriber should compare the full panel rather than a subset.
Standard deviation: A single number quantifying how much an investment's actual returns fluctuate relative to its OWN average. A higher figure means a wider range of possible returns and therefore greater volatility.
Systematic risk: Risk applying across the board to all sectors and companies — inflation, political risk and the like. It cannot be diversified away, and it is what beta measures.
Tax-adjusted return: Return after tax — pre-tax rate × (1 − tax rate). It shows what income is actually available to meet expenses, and it depends on the individual investor's tax status and slab.
Tax-free bonds: Bonds issued by public sector units in the infrastructure sector whose interest is untaxed in the investor's hands — and which are therefore issued at a lower rate than taxable bonds of similar credit quality and tenor.
The active management standard: An actively managed fund is expected to beat its benchmark in both directions — rising more than the index in a rising market and falling less than it in a declining one.
The balanced portfolio prescription: The workbook's answer for an investor willing to take high risk on a short horizon: exposure to both equity and debt, giving better returns from equity and stability from debt, rather than the pure equity exposure the investor wants.
Total return: Periodic income plus the change in the value of the investment. Debt gives interest plus value change, equity dividends plus value change, real estate rent plus value change, and gold and commodities appreciation only.
Unsystematic risk: Risk specific to a particular investment, such as cyclicality in demand for a company's products. It can be reduced or eliminated from a portfolio through diversification.
Why equity returns are volatile: Because dividend income is a small part of the total and capital appreciation the major part — the same fact that gives equity its greater growth potential.
XIRR: The Excel function computing the internal rate of return where there are multiple cash flows on different dates. It needs cash outflows (entered with a minus sign), cash inflows and the corresponding dates.

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Original explanatory writing based on the official NISM workbook for Series XVII, which is published and copyrighted by NISM. Check figures against the current edition at nism.ac.in.

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