Retail Investors who are new to Mutual fund, often tend to completely rely on past performance in mutual funds as they lack investing knowledge of current market trends. Most of my clients who are new to investing, questions how can retail investor like him/her know which scheme is good? As retail investor just like that cannot call the Fund manager and enquire about the potential of the scheme.
Many investors also doubt on the amount of insight an average IFA (Independent Financial advisers) has into the fund manager investing style and strategy.
Since quite some time, many investors and advisers are trapped in the myth called “Past performance of Mutual funds”. Instead of challenging the concept of Past performance of funds, there has been nonstop debate if long term performance (3-5 years) should be considered as deciding factor in mutual fund selection.
Why Past performance shouldn’t be a deciding factor
Saturation and Downfall is a part of every product’s life cycle, what matters the most is how long that product lasts at maturity stage. Similarly last year’s top performing mutual fund schemes will eventually not show up in top list of current year. Worth to mention that investors and financial advisers who invested in Top 5 performing Mutual funds schemes of year 2015 faced huge disappointment as none of those 5 schemes appeared in top in year 2016.
I will share some real time instances which will help understand past performance in mutual fund should not be key deciding factors. And also I will list down what are key factors you should consider while selecting the schemes.
Kotak Nifty ETF
Kotat Nifty ETF is a large cap open ended fund, which was a good performer with a track record of high returns from the launch date January 2010. Investors who selected Kotak Nifty EFT by looking at its steady performance had face huge disappointment in year 2018.
Seeing the below figures of Kotak Nifty ETF performance you understand that in 2018 this fund had a huge downfall and ROI went 6.20% to -6.38%.
Source : Economictimes
Reliance Focused Equity Fund
Reliance Focused Equity Fund previously known as Reliance Equity Fund was launched on Dec 26, 2006 was a very bad performer in large cap category till December 2011. You would be shocked to know from 2012 it has been placed in top list in large cap category. Investors who picked Reliance focused equity fund in December 2011 despite of having a bad past performance were rewarded with 41% returns.
Source : Economictimes
Can returns over longer period indicate future returns?
Performance of a mutual funds is not defined only by its returns. You should know that performance of mutual funds is different from returns from mutual funds.
Most of the time, good performance can be a negative indicator. Let me list down few explanations: One is that an isolated year of unusually high returns is abnormal. Investing is a marathon, not a race; it should be boring, not exciting. Strong performance is not sustainable. Another reason to stay shy from high short-term performance is that this attracts more assets to the fund.
All that glitters is not gold
“All that glitters is not gold” Well past returns can be an indicator of returns from future, given that if market trends and conditions is alike in past and the future. However it is not that simple, as this theory may not apply on short term returns. Short term returns mostly are misleading as the market conditions prevailing in last 2 years may not prevail in upcoming 2 years.
Not just short term (1 year – 2 years) returns are not reliable for future return expectations. Even the medium term (3 years) returns are not reliable for future return expectations. For that, even very long term returns are not suitable if they include black swan events of if the fund strategy or governing norms have changed over the long term period.
Investors should look at the past performance but not overlook it and select schemes only based on the past performance. Investors should first explore his trading choice and then relate it to the trading style of fund manager. Importantly investors should also analyse how adaptive is his fund manager strategy with the bull and bear market. Seeking advice from professional financial advisors is also a good idea.