If you examine the performance of equities mutual funds (MF) over the previous several years, you will notice that no fund consistently ranks among the best. This provides a fair amount of evidence in support of the commonly stated disclaimer, “Past performance does not guarantee future results.”
Investors do, however, look for performance. Those who must choose a fund in any particular year sometimes select schemes based on the previous year’s performance or search for the top-performing schemes. They believe that if something performed well the previous year, it will undoubtedly perform well in the following years. However, that is not at all true if you know what is AMC. It is statistically difficult for an investment scheme to consistently perform as the best in its category throughout several market cycles and years regarding a specific fund category.
Many begin a 12-month systematic investment plan (SIP) in a fund that has performed the best during the previous year. Once the SIP has ended for a year, they select a different fund that performed exceptionally well the next year and launch a new SIP. This is not a wise decision. The selection of funds should never be made only based on short-term results. There have been several cases where a fund that performed in the lowest 10% one year suddenly rose to the top 10% the next year and vice versa.
The Temptation of Chasing Past Performance
Success attracts humans like a magnet, and it’s the same in the investment world. A mutual fund attracts more prospective shareholders if it outperforms its peers the previous year. The attraction stems from the dream that the fund may keep its strong performance and thus produce better results for investors willing to join it.
The Pitfalls of Chasing the Past
Investing in a mutual fund that performed best in the previous year may seem logical. However, one should understand the high risks of such an investment strategy. The dynamic financial market encompasses many factors, such as economic changes and geopolitics. A record should not be equated to future performance simply because a fund has been successful on one occasion does not mean it will succeed again.
Market Dynamics and Cyclical Nature
Markets undergo cycles where some particular sector or asset class may show drastically different performance from the following year. In a bearish market, for instance, an outperforming fund may not repeat its past performance due to changes in market dynamics. Economic recessions can influence the performance of a mutual fund, increase or reduce interest rates, or change demands for a product.
Overvaluation and Correction
Occasionally, a popular winning mutual fund is overvalued. Growth can cause a fund’s price to rise so high that there is no room left for additional growth. There is, however, an increased probability of a market correction, which may lead to a reduced payout for fresh investors.
Managerial Changes and Strategy Shifts
The people managing a mutual fund and the tactics they use significantly impact how well it performs. Modifications to the investment plan or shifts in fund management may dramatically impact returns. Investors need to be informed about any changes in management or approach within a mutual fund.
The Balanced Approach: Due Diligence and Research
Instead of just depending on last year’s performance as a reference, companies should conduct proper investigation before any decision-making. However, investors should assess a fund’s performance for long periods and under different markets.
- Fund Objectives and Strategy: It is essential to understand what the fund is meant to achieve and its investment strategy. Sustainable returns are possible when a strategy is well-defined and matches the investor’s risks and financial objectives.
- Risk Management Practices: It is also necessary to look into the fund’s risk management practices. A strong risk management strategy creates a more resilient fund to overcome uncertainties and turbulent markets.
- Long-Term Viability: As such, investors ought to have an eye on the mutual fund’s ability to sustain itself for the long term and not just short-term gains. The ability of an investment fund to withstand different market conditions can be shown through continuous and stable performance for many years.
Undoubtedly, such an option seems fascinating to investors. However, every investor should be very careful in making decisions on how to act while choosing last year’s winning mutual funds. The past is an informative guide but should not be the only basis for investment decisions.
Investors ought to carry out extensive studies of the various funds, comprehend the fund’s goals, and take into account some broader market elements for them to make rational judgments regarding the potential investments.