What absolute return measures
Absolute return is the gain divided by what went in. ₹3,60,000 invested and now worth ₹4,50,000 is a gain of ₹90,000, which is 25%.
It says nothing about time. That 25% could have taken one year or ten. For a SIP it also hides something more important: most of the money has not been invested for the whole period.
Why it misleads for a SIP
Take ₹10,000 a month for three years. The first instalment has been invested for three years; the last, for a few days. On average, the money has been at work for about half the period.
So the same ₹90,000 gain was earned on money that was invested, on average, for about eighteen months rather than thirty six. Measured per year, that is a much better result than “25% over three years” suggests.
What XIRR measures
XIRR is the yearly rate that, applied to each instalment from the day it went in, produces today’s value. Every amount is weighted by how long it was invested, so money that arrived last month counts for last month only.
It is the same idea as CAGR, made general. CAGR describes one amount growing between two dates. XIRR describes any number of amounts, in and out, on any dates, which is what a real portfolio is.
A worked example
Two clients each invest ₹3,60,000, and each is worth ₹4,50,000 three years later. Absolute return is 25% for both.
The first invested it all on day one. Their XIRR is 7.7% a year.
The second invested ₹10,000 a month for thirty six months. Their XIRR is 15.0% a year: roughly twice as much, because their money was invested for about half as long on average.
Same money in, same money out, and one result is twice as good as the other. Absolute return cannot show that. XIRR can.
When not to state it
Under a year, a yearly rate is an extrapolation. A fund up 4% in three months is not a fund that returns 16% a year; that is a guess about the next nine months presented as a fact.
Show the rupees and the absolute return instead, and state the yearly rate once there is a year of history behind it.
One sentence for the client
“XIRR is your return per year, counting each instalment only from the day it was invested, so it can be compared fairly with a deposit or with another fund.”
Sahi Capital states each holding’s own XIRR in the review, and a money-weighted rate for each fund house and for the whole book. Under a year it shows the rupees and says why.