Working with money managers (listed equity mutual funds/PMSs/AIFs) is the aspect of the investment process that is typically the most exciting for investors but possibly contributes the least to their wealth growth. Observing those who are most obsessed with money managers is one of the most effective methods for identifying investors who are likely to have relatively little success over time.

Decoding reasons

First reason - Services of some managers are overpriced in comparison to the value they deliver to consumers. Look no further than the expense ratios of actively managed large cap funds, of which 93.8% underperformed the S&P BSE 100 benchmark over a five-year period according to the SPIVA CY year-end report for 2022. If mutual funds struggle to outperform the benchmark, PMS products should be the solution, right? The overwhelming majority of relatively expensive multi/flexi cap PMS products have underperformed their respective categories in the mutual fund industry. Due to the pass-through of the capital gains tax on intra/inter-year portfolio turnover to the investor, the bar for delivering superior net returns is higher for PMS products compared to diversified equity mutual funds.

Second reason - There is no statistical evidence of persistence of performance. The mutual fund/PMS ranking systems (and sites) exist and are as popular as they are because investors cannot tolerate the ambiguity that is dictated by this simple fact: future performance will be random based merely on past performance. Over the next five years, a portfolio of five-star funds will either outperform a portfolio of one-star funds, or it will not.

Tracking mid-cap funds’ performance

We prepared an analysis using a group of 21 mid-cap active mutual fund managers and compared relative performance over time. The general consensus among investors is that competent managers should be able to add value in inefficient sectors with some consistency over time. As a result, the exercise’s goal was to discover how often managers remained outstanding performers over time.

Of the top 5 managers in 2017 (CY ending annul return), none remained in the top 5 by 2022 (CY ending annual returns). On the other hand, the manager who finished second last (20th) in 2017, was the number one rated manager by 2022 (CY returns). Put differently, investors who hired any of the top performers in 2017 would have been badly disappointed by 2022.

Wealth accumulation determines the extent of value addition. To demonstrate this point, we assumed that each of the afore-mentioned 21 midcap managers mentioned above was given Rs 50 lakh at the start of 2018, and we computed their wealth accumulation through 2022 (five years) based on their compounded returns over that period. The best performing manager at the end of 2022 had accumulated a whopping ~ Rs 80 lakh (approx.) in gain on an initial investment of Rs 50 lakh. Unfortunately, that manager was ranked 20th out of 21 managers at the end of CY 2017 (based on CY annual performance), and hence was quite unlikely to be selected by investors in 2018.

The number one ranked manager at the end of 2017, ended up accumulating only ~ Rs 23 lakh (approx.) on an investment of Rs 50 lakh over the period. Based on the recent performance in CY 2017, this manager was likely to have been hired by investors at the start of 2018.

The lack of persistence of manager underperformance was not unique to this category. To dispel misconceptions that this was a study of selectivity, we examined the performance of another mutual fund equity category known to carry significant active risk - focused mutual funds. At the conclusion of calendar year 2017, there were 16 managers in this group in our analysis. In this category, the top three managers at the end of CY 2017 (based on CY ending annual returns) were actually the bottom three at the end of CY 2022 (same universe of 16)!

These findings reinforce our view that persistence is very rare.

Irrelevance of recent performance

The primary issue - recent good performance is almost irrelevant.

1)     Recent success (good track record) could be a consequence of fortunate timing - Consider a ten-year-old money manager who has delivered ordinary outcomes for eight of them. For reasons neither we nor (probably) the manager know, performance has been superb for last two years. The manager’s five-year record is now respectable after two “lucky” years. Thus, many unlucky investors, impressed by this recent track record, will choose an average manager who can be trusted to continue with inconsistency in delivery.

2)     Recent good track record could be a result of style rotation - Consider the hypothetical case of Value Capital fund. As a follower of the value style, “Value capital” excels when value stocks are popular and struggles when growth stocks are popular. After strong relative outperformance of value as a factor, Value capital aggressively markets its recent record and increases its asset base. When value as a style goes through a lean patch, Value capital struggles to retain clientele. This leads to a cycle of rapid asset expansion, followed by weak or even contraction, and then strong growth again. Investors purchase high and sell low & often mistake & attribute recent good performance to manager’s prowess instead of attributing it to a significant sector rotation effect. The same fate might befall a notional “Growth capital” fund that is heavily tilted towards high growth style.

3)     Recent success is trustworthy, but the manager’s firm has changed - In addition to ensuring that the track record is genuine, investors should always ensure that the firm that produced the track record is the firm they are hiring. The firm may have changed, for instance, because its asset base has grown significantly, and its founding professionals can no longer oversee the growth of business and select excellent stocks simultaneously. Or the firm may have changed because the investment professionals who built the performance record are no longer employed by the organisation.


Am I implying that high-performing managers cannot be identified in advance? I most certainly am not. Simply, I am asserting that future superior performance cannot be inferred based solely on prior superior performance.

An advisory firm with highest of standards, will seek managers with the following qualities: adherence to an articulable investment strategy that is intellectually acceptable; demonstrated long-term commitment to and competence in the asset class, sub-class, or investment style; and demonstrated commitment to keeping investment costs optimal relative to the expected incremental return. To discover skilled and dependable true to label managers, an extensive multi-level screening approach is required.

As an investor, in addition to working with capable managers, two important attitudinal traits together with an important portfolio practice when followed will keep your capital on a steady compounding course. These are:

Patience & discipline – Staying focused on the plan rather than reacting to events/fads of the moment. When discipline fails, the plan fails.

Asset Allocation – Long-term portfolio performance depends relatively less on selection and timing. Asset allocation—the long-term portfolio combination of Equities, Bonds, Gold, REITs, InvITs, Real estate and Private equity—is a bigger factor.

The author is Managing Director, Head of Discretionary Investment Services, Waterfield Advisors