Mutual fund is really a mistake? If you look at the performance of equity MF over a number of years, you’ll notice something: no single fund has consistently performed at or near the top. That’s pretty solid evidence for the oft-quoted caveat, “Past performance is no guarantee of future results.”
However, it is a known fact that investors seek out returns. Those in need of selecting a fund in a given year will frequently select schemes based on returns from the prior year, or seek out schemes that are the top performers. They believe that if something was successful in the previous year, it will continue to be so in the subsequent years.
That, however, couldn’t be further from the truth. A scheme (within a given fund category) cannot consistently outperform its peers over multiple market cycles and years.I have come across people who start a 12-month SIP in a fund which has done the best in the past one year. After a year, once the SIP stops, they again pick another fund which did the best the following year and start a new SIP.
This is unwise. Fund selection should never be based solely on near-term performance. There have been many instances where a fund that was in the bottom 10 percent in one year shot up to the top 10 percent the next. There have been several cases of the reverse too.
Don’t just rely on how you did in the past.
So, if you shouldn’t choose funds based on how well they’ve done in the past, how do you choose which ones to put in your portfolio?
You shouldn’t just look at what was at the top of the table last year. You also shouldn’t just look at point-to-point returns for the last one, two, or three years. Instead of looking at point-to-point returns, it’s much better to look at rolling returns for all the funds first.
Consider things like the fund’s risk parameters, how volatile it is compared to the market, how often it beats or underperforms the benchmarks, consistency ratios, the scheme’s performance compared to its peers in the same category across cycles, etc., in addition to rolling returns. I would also recommend doing a personal evaluation of the fund manager and the team’s track record, as well as the methods used to build the portfolio for the scheme. But it’s easier to say than to do. Not just for small investors, but also for people who think they are experts.
I’m not saying it’s wrong to look at how things worked in the past. All I’m saying is that it’s not enough. You need to use other criteria to narrow down the funds you want to add to your portfolio.
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A winner might not work for you.
Typically, sector or theme funds offer the highest returns. However, when they succeed, they receive all the attention. This is due to the fact that their good years follow years of average or poor returns. Therefore, the majority of investors are unsuitable for sectoral and theme-based funds.
10–20% of the portfolios of sophisticated investors who understand the risks and how to time their entry and exit can be allocated to sector funds. But you should avoid the remaining individuals.
Long-term, smallcap funds can also profit. In a bad economy for small businesses, these funds can lose a lot of value despite their high returns. They’re also not for everyone because their returns vary.
Markets have other attractions. Two-year successes attract capital and investors. The AUM increases. In some categories, the fund manager may struggle with the mutual fund’s size.
It’s similar to this.
Small cars are easy to move around. But that won’t work if you are driving a truck.
It’s best to invest in a few funds with different market-cap segments and styles with little portfolio overlap when building your MF portfolio. Investors should do well with that. Use passive index funds to avoid picking mutual funds.
Don’t invest only in top performers. Talk to a financial advisor about planning your finances with good funds if you’re still unsure.
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