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Following the same strategy, the 25th, 26th, and 27th rankers every year give us 9.5% returns if we had continued to invest in them for the entire 10 year period. Scenario 2: Invest in Any Fund Expect the Top 3 Funds and Hold Investmentsīut what happens if you pick the middle rankers (say 25th, 26th, and the 27 th ), mid-low rankers (50th, 51st, and 52nd), or even lowest-ranked (73rd, 74th, and 75 th ) schemes?Īs we mentioned earlier, the top ranks, i.e., rank 1, rank 2, and rank 3 give us 12.6% annualized returns. So, in 50% of the cases, the top performers dramatically underperformed in the very next year of observation.Īs you can see, the approach of looking at the only past performance to decide which fund you will invest in is not a smart idea. Out of these 27 investments in funds ranked 1, 2, or 3 when we made the investment, 13 out of these 27 investments faced a bottom half performance in the very next year of investment. If we ignore the investments made on the 1st of January 2020, we have made a total of 27 investments, i.e., 3 per year for 9 years. There were some funds that had a significant fall from grace. These years of low returns have pulled down the overall portfolio returns. As you can see, in many instances, a high performing fund has had many years of low. In the table above, you can see the funds we invested in each of these years marked in green and also their ranks in the subsequent years. Performance of Top Performing Fund in Subsequent Years This return percentage isn’t that great, and that’s mainly because our top-ranked funds of a particular year did not replicate their success in most of the following years. 2.7 lakh, and the current value of these investments as of the 1st of December 2020 would have been Rs. So over the last 9 years, we would have invested Rs. And then, we continue this pattern for 2014, 2015, 2016, and so on. These investments will be retained for the next 8 years until 2020. 10,000 in them on the 1st of January 2013. Next, similar to what we did on the 1st of January 2012, we picked the top 3 performing funds of 2012 and assumed we invested Rs.
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The important thing to note here is that we assumed will not sell the units received in these schemes and are going to retain them for the next 9 years, i.e., until 2020. 10,000 each in SBI Focused Equity Fund, Canara Robeco Bluechip Fund, and Axis Long Term Equity Fund, which were ranked first, second and third for that year. 10,000 in the funds, which ranked 1, 2, and 3 from this list. Now, we followed the simple step of ranking these 75 funds per the 2011 returns data and assumed we invested Rs. So, from 2011 onwards, let’s say we are sitting on the 1st of January 2012 and have the 2011 annual performance data available to us. We first looked at how would a portfolio have performed if one were to buy only the top 3 funds every year? Scenario 1: Invest Only in Top 3 Funds of Last Year and Don’t Sell 500 crores.įurther, we kept our interest in the large-cap, large & mid-cap, multi-cap, and ELSS categories as they generally have a good overlap in portfolio and market capitalization constructs.Īll this gave us a set of 75 mutual fund schemes to work with, which is a pretty significant number. Now there are many funds, but we focused our attention on only those schemes which had at least 10 years of performance history under their belt and a minimum AUM of Rs. We begin this effort to study the effectiveness of a hire-and-fire mutual fund strategy with the fund selection process.
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It is this distorted view of reality that often leads to many investors becoming performance chasers, which means they often sell their holdings in slow performing mutual funds and reinvest the proceeds into recent winners.īut this work? Well, we looked at the data to find out. And if a potentially wrong decision turns positive, although it might be purely luck, it is treated as a sign of superior decision making. The problem with this is that if a good decision goes bad, then it is promptly treated as a sign of poor decision making.
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So while something happened, we don’t have any idea of why it happened. For the 20 years, the Securities and Exchange Board of India and the mutual fund companies have been touting the message – “Past performance is no guarantee of future results.”Īnd yet, tens of thousands of mutual fund investors operate under the powerful grips of what is called an outcome bias.Īn outcome bias arises when a decision is based on the outcome of previous events, without any regard to how those past events developed.