Mutual Funds

Equity MFs: Chasing the top performer gives middling returns

Kumar Shankar Roy BL Research Bureau | Updated on January 24, 2021

There’s no reason to bail out of your fund as long as it’s matching the category average

An analysis of yearly returns of equity funds over the past 10 years shows that chasing performance is not worth the trouble and can leave you with sub-par returns.

Often, investors eagerly look out for equity funds that topped the performance charts at the end of each year, and switch into them in the hope the winners will score an encore over the next 12 months.

Such churn may help distributors or the fund industry, but ‘follow the leader’ strategy does not work for the investor.


Blind faith

If you had diligently executed the ‘follow the leader’ strategy at the beginning of each new year, across the 200-odd equity funds between 2011 and 2020, you would have invested in Nippon India Banking Fund in 2011 — the best performer in 2010 with a 46 per cent annual return. In 2012, you would have jumped to ICICI Pru FMCG Fund. A new theme scored each year — pharma in 2015, natural resources in 2016 and tech in 2018, for instance.

Had you followed this rear-view mirror strategy with a starting investment ₹1 lakh at the start of 2011, your final corpus by the end of 2020 would be just ₹1.8 lakh. The money would not even have doubled in 10 years; in fact, the strategy would have yielded less than index returns. While the Nifty 50 gave 9.9 per cent CAGR between 2011 and 2020, your chase of “performance” would have got you about 6 per cent.

Sticking to categories?

Clearly, following hot themes or sectors can lead you astray. But does follow-the-leader work within more diversified equity fund categories such as large-cap schemes? Not really. Starting with ₹1 lakh in 2011 would have fetched you ₹2.02 lakh by 2020-end had you jumped to the top large-cap fund each year, with a CAGR of just 7.3 per cent. The Nifty 100 index delivered a 10.2 per cent CAGR in the same decade, which means ₹1 lakh became ₹2.6 lakh without breaking a sweat.

The story is the same if you had chased the mid-cap leaders. Beginning with ₹1 lakh at the start of 2011 would have given you ₹3.62 lakh, a CAGR of 13.7 per cent. If you think this is a great return since your money tripled, you are missing the point. There was a secular rally in most mid-cap funds during this period.

The same story was repeated with small-cap funds, too, where churning your holdings each year would have yielded 8.8 per cent CAGR, or ₹2.33 lakh, by 2020 end. But the small-cap index gave 8.5 per cent in the same period, with zero hassle. Remember that churning your holdings each year entails effort in terms of closely tracking the fund space. It also involves expenses and short-term capital gains tax that can take a big bite out of returns.

Average better than topper

The message is loud and clear: there’s not much to gain in following the leader each year. So what must you do? Simply staying put in your middle-of-the-road fund delivers better returns. Had you stayed with an average performer among all equity funds every year, it would have turned your ₹1 lakh into ₹2.78 lakh, or a 10.77 per cent CAGR, between 2011 and 2020.

‘Being average’ works for specific categories, too. If you got average returns, ₹1 lakh would have become ₹2.55 lakh (9.81 per cent CAGR) in large-cap, ₹3.62 lakh (13.7 per cent CAGR) in mid-cap and ₹3.32 lakh (12.75 per cent CAGR) in small-cap.

The takeaway here is there’s no reason to bail out of your fund as long as it’s matching the category average.

Published on January 23, 2021

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