Why past mutual fund returns is a bad indicator of future returns

When you invest in any mutual fund scheme, the first thing you may have done most likely is look at recent returns and invested in funds with the highest returns.

As much as this seems like a great way to begin, it can actually be very misleading.

Past mutual fund returns like statistics often reveal what could have been concealed and hides what should have been concealed.

This is why you should not invest based on internet search results of:

  1. Best performing mutual funds
  2. Best sip plans
  3. Top performing mutual funds

So how do you study mutual funds performance?

top performing mutual funds

SEBI Recategorization

Mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI).

The regulator SEBI in 2018 decided to undertake recategorization exercise of mutual funds according to which mutual fund schemes would have to invest according to certain set rules.

These include but not limited to:

  1. A Large cap fund needing a mandatory 80% allocation into large cap stocks.
  2. A Mid cap fund needing a mandatory 65% allocation into mid cap stocks.
  3. A small cap fund needing a mandatory 65% allocation into small cap stocks.
  4. A Large & mid cap fund needing a mandatory 35% allocation each into large cap and mid cap stocks and so on.

What these new rules meant was now mutual fund schemes had to either rejig their portfolio or move them to a completely new category.

Additional reading: Click Here to read our complete review of Kotak Standard Multicap Fund

These new rules therefore made past performance/returns of mutual funds redundant.

  1. Invesco Growth Opportunities Fund, currently a large and mid-cap fund was previously a large cap fund.
  2. Kotak Standard Multicap Fund, currently a multicap fund was previously a focused fund.
  3. Parag Parikh Long Term Equity fund, currently a multicap fund was previously a value fund.

Imagine if you had invested in these mutual funds based purely on their past returns without considering the change in their:

  1. Category
  2. Investing style
  3. Portfolio strategy
  4. Sector allocation
  5. Stability
  6. Your future goals
  7. Your risk profile 

Are you investing in the right mutual funds?

Fundamental changes to Fund scheme

Any mutual fund scheme at any time could undergo changes that could change it completely from what it is was in the beginning.

Case in point:

When Mirae Asset Multcap fund changed its category from multicap to a large cap fund.

top performing mutual funds


This completely changed the fundamental characteristics of the fund, as a multicap fund it could invest across all caps with no restrictions but as a large cap fund it needed a mandatory 80% allocation into large cap stocks.

You therefore cannot expect a large cap and multicap fund to perform similarly even though they belong to the same fund house.

Another example could be when SBI small cap fund stopped accepting fresh lumpsum investments into its fund and allowed investments via SIP and STP.

top performing mutual funds


How a fund receives money and the flow also matters, more so the case with mid and small cap funds.

  1. Expecting the fund to behave similarly in both cases be it with returns or volatility would not be fair.
  2. In both the examples with changes to the funds, you cannot compare past returns with current returns and should not expect future returns to be in line with past returns.
  3. Although this should be the case for any equity mutual fund, it is so more the case when the fund has undergone significant changes thereby completely changing how it is run. 

Fund Manager

Let’s say you have done no research on the fund manager and just looked online for general terms like ‘top performing mutual funds’ and ‘best sip plans’.

The funds that come up in search engines would usually be the ones with the highest returns in recent times.

What you would not be aware though is the cause for these so called high recent returns.

Sometimes a particular mutual fund may have done well recently due to its bet on a certain or a couple of sectors coming off well.

Principal Focused Fund in 2019 allocated a higher allocation towards the Chemical sector, the fruits of which it bore in 2020.

Not all sectors do well simultaneously and not all bets pay off the way we want them to.

In a similar manner a reputed fund manager and fund house has recently come under harsh criticism for its over exposure to Public Sector Unit companies.

There’s no way to confirm that this strategy will not work in the future too because times change, economies undergo transformations and mutual fund schemes also go through various ups and downs.

Are you investing in the right mutual funds?

Knowing why your mutual fund is doing well is as important as knowing why your mutual fund is not doing well.

Additional reading: Click Here to read our complete report of why you should NOT invest in Dividend mutual funds.

Fund Strategy

Two mutual funds of the same category with the same restrictions and possibilities can still be run very differently and thereby produce returns that could be miles apart.

With such mutual funds you would need to have a better understanding of how they function and whether or not they are aligned with your risk profile.

Invesco multicap fund has a higher allocation to mid and small cap stocks and thereby usually outperforms its peers when mid and small cap stocks rally and underperforms comparatively when mid and small cap stocks are volatile.


Assuming mid and small cap stocks are rallying thereby pushing up the returns of Invesco multicap fund too, the thing with mid and small cap stocks though is that they tend to be very volatile in the short run.

Now if you enter the fund based purely on recent high returns when mid and small cap stocks were rallying, you would be extremely disappointed when these mid and small cap stocks also underperform if the market is going through a volatile phase.

  1. You would assume your pick of fund is wrong, shift to another fund and thereby end up only resuming your mistake.
  2. This is because other multicap funds with lower exposure to mid and small cap stocks would have performed better due to lower volatility.

You need to understand your reasoning behind your choice of fund before investing, when staying invested and also when you decide to redeem.

Another case study for better understanding here could be Parag Parikh Long Term Equity fund.

top performing mutual funds

The fund has outperformed its peers for the period between April 2020 to September 2020.

A period of 6 months for an equity mutual fund life is extremely short to make any meaningful conclusion out of it.

Anyway, what contributed to the funds outperformance during these 6 months could be attributed to the following points:

  1. Higher cash bets
  2. Exposure to US companies
  3. Minimal exposure to mid and small cap stocks.

Parag parikh long term equity has historically taken higher cash calls which helps it during a bearish market phase but works against it during a bullish market phase.

The fund’s international exposure was limited to US stocks except for one and all these US stocks were confined to the technology space.


The US stock market is more technology driven whereas its economy is more consumer driven.

The fact that IT companies could afford to have their employees work from home with little to no disruption to their work was nothing short of a privilege considering the times.

There’s no way Parag Parikh Long Term Equity fund could have predicted the entire world going through such difficult times, let alone global economies.

Now you cannot enter the fund expecting same, similar or linear returns too because times were different back then, are different now and will continue to be different in the future.

May be the fund could cut down its exposure to US and US based IT companies in the future or may be these companies could be left behind by other sectors or companies within the same space.

The performance of Parag parikh long term equity fund would have been different in the past as compared to the 6 month period and therefore it becomes all the more important to understand the functioning of any equity mutual fund.


    Goals and needs should take precedence over returns and wants when making a mutual fund portfolio but unfortunately the opposite of that is true, more so with first time and inexperienced investors.


    We are living during times when there is so much noise with business news channels, newspapers and apps and yet little to no knowledge as to how to go about building and maintaining one’s mutual fund portfolio.


   We have too much unnecessary information and yet very little credible knowledge.


   When you keep on chasing recent returns you end up buying and selling, that is trading and not investing.

This has implications on:

  1. Your taxes
  2. Your portfolio
  3. Exit load charges


     Sooner or later you would get the feeling that mutual funds are not the right source of investment for you, when in fact you never were able to utilise the resources in hand very efficiently. 

For portfolio enquiriesemail us with your doubts at info@themutualfundguide.com

Disclaimer : While due precaution has been undertaken in the preparation of this article, The Mutual Fund Guide or any of its authors will not be held liable for any investments based on the above article. The above article should not be considered financial advice and has been published only for your perusal. Due credit has been given in case wherever required, in case you feel any part violates any rights then do get in touch with us and we shall get it duly removed.  
Mutual Fund investments are subject to market risks. Please read the offer document carefully before investing

Copyright © 2020  The Mutual Fund Guide, All rights reserved

My Instagram