Mutual funds: Past performance not always guarantee future return; how to choose mutual funds to get best return
Mutual Fund.
Meanwhile, investors in struggling funds have voted with their feet. In the large-cap segment, just two funds accounted for 75% of the outflows.
It turns out they have been among the weakest performers over the past three years. In the mid-cap space, the bulk of outflows are from two schemes. This investor behaviour—latching on to recent winners and dumping the losers—makes sense intuitively. However, investors are only setting up their portfolios for a sub-par performance. Here is why.
Fund performance is cyclical
The basic premise for chasing top performers— the belief that past success will continue into the future—is flawed. Chasing past returns is a futile exercise. Funds, like the broader markets, tend to perform in cycles. The ups and downs in a fund’s life cycle are inevitable. A period of outperformance is typically followed by a period of underperformance, and vice versa. This is particularly evident in funds where outperformance is very sharp, observes Sachin Jain, Research Analyst at ICICI Direct.
It is impossible for a fund to remain a top performer across market cycles. Data from FundsIndia shows that only one out of four top performing funds over a three year time frame continued to remain in the top quartile over the next three years. Over five-year time frames, only one out of five funds could manage this feat. Vivek Banka, Co-Founder, GoalTeller, observes, “Reversion to mean is a fundamental investing axiom, and sooner or later some of these funds and stocks revert to averages.”
