Mutual Funds Sahi Hai?

A purely American creation, the Mutual Funds was introduced in 1924 by a former salesman of aluminium pots and pans named Edward G. Leffler. Mutual funds are quite cheap, very convenient, generally diversified, professionally managed, and tightly regulated under some of the toughest provisions.

But mutual funds aren't perfect; they are almost perfect, and that word makes all the difference. Because of their imperfections, most funds underperform the market, overcharge their investors and suffer erratic swings in performance.

Most investors simply buy a fund that has been going up fast, on the assumption that it will keep on going. And why not? Psychologists have shown that humans have an inborn tendency to believe that the long run can be predicted from even a short series of outcomes.

Let's look at what the data says

The images below show the rank based on 1 year returns at the beginning of the year, each year and how the ranking has changed over the next few years, across all categories – Large Cap, LargeMid Cap, Multi/Flexi Cap.

Most funds that topped the ranks in 2019 have come to the bottom in 2023.

Why don't more winning funds stay winners?

Reasons

1. Migrating Managers

When a stock picker seems to have a Midas touch, everyone wants him/her - including rival fund companies.

If you bought Fidelity Aggressive Growth Fund in early 2000 to capitalise high returns of Erin Sullivan who had nearly tripled shareholder's money since 1997, it would not play in your favour as she quit to start her own hedge fund in 2000 and her former fund lost more than three-quarters of its value over the next three years.

2. Asset Elephantiasis

When a fund earns good returns, investors notice, often putting in more capital in a matter of a few months.

That leaves the fund manager with few choices - all of them bad. He can keep that money safe for a rainy day but get a low return on cash.

He can invest in stocks the fund already owns, which may now be at a higher price and drive up prices further.

Or find new opportunities that he must have already stumbled upon before but chose not to.

3. Herding

Once a fund becomes successful and of a large size, its managers tend to become comparatively timid and imitative. The biggest funds of the same category have nearly the same stocks in their top holdings.

4. 𝐄𝐱𝐩𝐞𝐧𝐬𝐞𝐬

Operating expenses and trading costs are often higher for these funds and these costs rarely fall with rising AUM.

What could be a possible solution for the passive investor?

Index Funds or ETFs

We are soon launching an ETF basket that addresses several drawbacks of Mutual Fund Investing

About the Author

Rohan Borawake is a SEBI Registered Investment Advisor and Finance Writer dedicated to providing valuable insights through his blogs and articles, catering to both everyday individuals and investors. For more of his content, follow him on LinkedIn by clicking the link - Rohan Borawake.

To gain a more profound understanding of quantitative analysis or witness its application in action, consider following Sabir Jana, the Head of Quantitative Research at Finsharpe, on LinkedIn. Click the provided link to connect with him on the platform- Sabir Jana

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