Every year, mutual fund rankings create a familiar temptation. A delivers 30-40% returns, a thematic fund doubles investors’ money, and investors begin asking the same question: Should I move my money there?
The answer, more often than not, is no.
“The belief that yesterday’s winners will continue to be tomorrow’s winners is one of the biggest misconceptions in mutual fund investing,” said Debasish Mohanty, chief strategy officer at The Wealth Company Mutual Fund.
What do return tables fail to tell investors?
The biggest limitation of return rankings is that they only tell investors what has already happened.
According to Rishabh Garg, CEO-Digital at FundsIndia, one-year returns reflect a specific market environment, including which sectors were in favour and which investment styles worked during that period.
“One-year returns tell you what happened in a very specific market phase. They say almost nothing about what will happen next,” he said.
FundsIndia’s research shows that only about 1 in 4 top-quartile funds remain in the top quartile over the following three years.
Mohanty noted that a fund’s recent returns are often influenced by prevailing market conditions, sector concentration or a particular style of investing that happened to outperform. There is little assurance that the same conditions will continue.
When does past performance become a liability rather than an advantage?
Funds generally rise to the top of performance rankings after a significant rally in the stocks, sectors or themes they own. By the time investors notice the outperformance, valuations may already be elevated.
“A major mistake is buying high without realising it. Last year’s top fund got there by running hard. When you enter now, you’re often entering at the peak of that particular style or sector cycle, not at the start of it,” Garg said.
Varun Gupta, CEO of Groww Mutual Fund, said investors often overlook the reasons behind a fund’s outperformance. A fund may have benefited from exposure to a specific sector, market-cap segment or investment style that happened to be in favour during a particular period.
By focusing exclusively on returns, investors can miss important factors such as portfolio construction, investment philosophy, risk profile, and performance consistency.
Mohanty added that investors also tend to ignore risk-adjusted returns. Two funds may generate similar returns, but one may have taken substantially greater risks to achieve them.
Why can switching SIPs after a bad year destroy long-term returns?
Performance chasing becomes even more damaging when it influences SIP decisions. Many investors stop in underperforming funds and redirect money towards the latest winners.
“There is a pattern we see repeatedly: investors switch out of a fund after 12-18 months of underperformance, move to last year’s winner, and then watch the original fund recover while the new one goes sideways,” said Garg.
He argues that investors often end up “buying the cycle twice” but on the wrong side both times.
Gupta said frequent switching can disrupt the discipline that makes SIP investing effective. Investors often begin investing in funds that have recently outperformed after much of the upside has already been realised, while exiting funds that may be poised for recovery.
Mohanty pointed out that such switches can also trigger taxes, exit loads and transaction costs. Studies worldwide have shown that investor returns often lag fund returns due to poor timing decisions rather than poor fund selection.
The categories where performance chasing can be most expensive
Experts agree that some fund categories are particularly vulnerable to performance-chasing behaviour.
Small-cap funds top the list. Their returns can surge during bull markets, attracting large inflows when valuations are often stretched. Sectoral and thematic funds present similar risks.
“Investors who chase sector funds are essentially trying to time not just the market but a specific industry cycle,” Garg said.
Gupta also highlighted strategy-specific and thematic funds, where concentrated exposure can lead to sharp swings in performance when market sentiment changes.
Mohanty cautioned that international and country-specific funds can be equally challenging because returns are influenced by currency movements, geopolitical developments and economic cycles, making recent performance an unreliable indicator.
What should investors look at instead of one-year returns?
Experts say investors should focus less on rankings and more on whether a fund can help achieve financial goals.
“A fund should be selected based on its ability to help achieve an investor’s long-term goals, not simply because it topped the performance charts over the past year,” Gupta said.
For investors, the real challenge is not identifying last year’s winner. It is staying disciplined enough to avoid chasing it.