Understanding Total Return Strategy

Total return strategy measures the performance of a security considering dividends and other cash distributions, capital gains and an increase or decrease in the net asset value (NAV) of a security, over a given time period, typically a year. The value of a security is the present value of expected stream of future cash flows that investors receive from the asset. The future cash flows are subject to the firm's earnings and thus they fluctuate from one year to another. Therefore, total return strategy informs the investor about the percentage gain or loss on a security compared to the purchase price.

Total return strategy are often calculated as follows:
Dividends + Capital gains distributions +/- amendment in NAV) / starting NAV

Example
We need to calculate the overall return of security X.

Data input

Dividend = $2
Capital gains distribution = $2
Initial net asset value (NAV) = 48
Increased net asset value (NAV) = $51

Plugging in the data in the formula we derive:
(2+2+ (51-48) / 42 = 7 / 42 = 16.7%

The total return strategy assumes that dividends have been reinvested in one year. It doesn't take into account any sales charges that an investor paid to invest in a fund, or taxes they might owe on the income dividends and capital gains distributions received.

Portfolio diversification is a methodology that investors use to anticipate price changes that have an effect on the net change in net asset value (NAV). A diversified portfolio allocates investment risk in different investment vehicles (stocks, mutual funds, bonds, and cash) offsetting losses from one asset with the gains in another asset of the portfolio. In doing so, investors diversify the risk even when investing in the same categories of assets with different expected rates of return. For instance, an investor may decide to invest only in mutual funds however with diversified investment strategies, including growth funds, balanced funds, index funds etc. The third methodology of portfolio diversification is investing based on industry or regional allocation. In doing so, investors may invest in both domestic and international funds therefore diversifying the risk of decreased rates of return because of industry recession or political or economic risk in a region.

Conclusively, total return strategy is a core portfolio strategy that seeks maximum return in line with the preservation of capital and cautious risk taking.

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Posted on Monday, 16 of January, 2012.