Should mutual fund investors always invest in toppers?

Many mutual fund investors, especially new and first-time investors, want to invest only in toppers of the performance chart. No wonder, most of their portfolios look the same. Some legacy funds and some new toppers figure prominently in all portfolios. That raises a question: should you always invest in toppers? Or can you always invest in toppers?

According to mutual fund managers and advisors, most investors don’t look beyond the top five funds in the return chart. Most of them don’t look beyond the performance of one or two years even when they are choosing equity mutual funds. That could explain why these investors are asking this question.

The first step is to figure out how these performance charts are made. Typically many charts use simple returns for short periods, say one year. If it’s above three years, the returns would be a compound annual growth rate or CAGR. If they follow star ratings, you will find out that the first quartile or 25% gets 5-star ratings. The second quartile gets 4-star, the third quartile gets 3-star and so on.

Do these tell you anything about the scheme? Sure, it tells you how much return a scheme made in a particular period. It also tells you how the scheme fared within the category. However, the performance may be distorted because of a great year. Or the scheme had a great run in the past.

That brings us to the utility of performance charts. The performance of the scheme is based on its past performance. It in no way can assume that the past performance would continue. That is the reason why mutual funds are mandated to make disclosure that past performance may or may not be repeated. If so, should you place too much emphasis on toppers in the performance chart?

According to mutual fund analysts, investors can use these charts as a good starting point. Beyond that they have no value, say these advisors. They say if a scheme is above average (that is, it is in the first 50%), investors need not be worried about its performance. Some advisors and fund managers say investors can look at the performance of the scheme in calendar years – if the scheme managed to perform six or seven years in a decade you should be happy. Be careful about flash in the pan performance.

No matter how hard you try your scheme is not going to be among the five toppers quarter after quarter or year after year. A fund manager may make certain calls in a particular period based on his market outlook. Sometimes certain calls will be wrong or the market may take time to recognise them. In such periods, the scheme may not be among toppers. But when a call is proven right, the scheme will be rewarded handsomely. If you hopped to another topper you would miss out those extra returns. Moreover, if the scheme has a bad patch, you will jump to another scheme. That is why fund managers say such a quest will be eventually proved futile.

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