There are various methodologies available to select which mutual funds to invest in – however, at the end of it all, one is still never sure as there is nothing predictive about any of these methods! Eventually, it’s a fund manager you are choosing – so you may know the risk style and stock selection but eventual performance? – impossible! Human behavior is unpredictable!
Why Diversification Matters
Mutual Fund advisors often recommend that their clients invest in a diversified basket of mutual funds – this is valid for multiple reasons including 1) Different portfolios and/or outlook, 2) Different styles of management, 3) Law of averages that some will do very well. And of course, most importantly, it is to also diversify away from the risk that selected fund houses may become “closet index funds” – even while charging you expenses of an actively managed fund!
There is a 5th very important reason to do so !
Factor 5: Fund Performance : Cyclical
History has proven globally that no fund manager can constantly beat indices – or even her peer group fund managers. Post the tumult of the SEBI recategorisation, this became more difficult- Recent performances showcase that – across equity categories , in the previous 6 months, hardly 50% of the schemes have outperformed their respective benchmarks. However, that is the subject of a different piece.
Being constantly in the top of the league is next to impossible – even in a simple category like Largecap Funds where there are virtually , at any point in time, hardly 50 stocks to select from. Why this happens may be due to a wide variety of reasons – as fund styles may differ from fund house to fund house even when the underlying portfolio may be the same – from Individual stock weightages to decisions on being value, contrarian or momentum to exit decisions on certain counters- all have an impact on eventual returns.
Cyclicality : Evidence from Recent Past
We took calendar year performance rankings of Largecap schemes from 2014 onwards (Largecaps as it is least troublesome – the universe for all the fund houses is smaller) and evaluated the annual performance of schemes that are best ranked today (descending order of basis last 1 year returns).
Their annual performance rankings within the space of 34 schemes present today are presented in the table below. (Example, Axis Bluechip is Number 1 on 1 year basis today but was ranked 31 in Calendar Year 2016)
| Fund | Fund Manager | Rank | 2014 | 2015 | 2016 | 2017 | 1 Year |
| Axis Bluechip Fund(G) | Shreyash Devalkar | 16 | 22 | 31 | 3 | 1 | |
| Edelweiss Large Cap Fund(G) | Bharat Lahoti | 22 | 16 | 29 | 7 | 2 | |
| UTI Mastershare-Reg(G) | Swati Kulkarni | 13 | 21 | 14 | 19 | 3 | |
| ICICI Pru Focused Equity Fund(G) | Mrinal Singh | 19 | 30 | 2 | 30 | 4 | |
| Reliance Large Cap Fund(G) | Sailesh Raj Bhan | 1 | 14 | 23 | 2 | 5 | |
| Sundaram Select Focus(G) | Rahul Baijal | 29 | 27 | 28 | 5 | 6 | |
| Canara Rob Bluechip Equity Fund-Reg(G) | Shridatta Bhandwaldar | 27 | 20 | 24 | 13 | 7 | |
| ICICI Pru Bluechip Fund(G) | Sankaran Naren | 15 | 18 | 5 | 10 | 8 | |
| Invesco India Largecap Fund(G) | Amit Ganatra | 20 | 5 | 19 | 23 | 9 | |
| Kotak Bluechip Fund(G) | Harish krishnan | 14 | 6 | 16 | 22 | 10 | |
| HDFC Top 100 Fund(G) | Prashant Jain | 7 | 32 | 3 | 12 | 11 | |
| IDFC Large Cap Fund-Reg(G) | Sumit Agrawal | 30 | 31 | 9 | 6 | 12 | |
| HSBC Large Cap Equity Fund(G) | Neelotpal Sahai | 28 | 29 | 4 | 16 | 13 | |
| Indiabulls Blue Chip Fund(G) | Sumit Bhatnagar | 32 | 7 | 12 | 9 | 14 | |
| Tata Large Cap Fund(G) | Rupesh Patel | 26 | 13 | 17 | 20 | 15 | |
| Franklin India Bluechip Fund(G) | Anand Radhakrishnan | 25 | 12 | 8 | 28 | 16 | |
| L&T India Large Cap Fund-Reg(G) | Venugopal M. | 10 | 19 | 27 | 21 | 17 | |
| LIC MF Large Cap Fund(G) | Sachin Relekar | 18 | 28 | 22 | 26 | 18 | |
| DHFL Pramerica Large Cap Fund(G) | Alok Agarwal | 12 | 11 | 20 | 24 | 19 | |
| JM Core 11 Fund(G) | Asit Bhandarkar | 3 | 25 | 1 | 1 | 20 |
Performance Data as of Aug 31, 2018
The analysis clearly shows that todays winners are almost all stark underperformers of the past – and vice versa!
So if you had gone by recent returns to select funds (Lets say you selected the top 4 funds of 2014, chances were you were getting below average returns in 2015. The same continues mostly across time periods .
Or alternatively , see the opposite. Look at the star performers of today – Most of these were bottom of the heap in the previous calendar years – and chances were you weren’t invested in them then!
Of course, there are certain schemes that are horrible across the time frames but then, one doesn’t care about them anyways.
A similar trend has played out in Midcaps as well. Basis past returns, you lost out mostly.
| RANKING | |||||
| Scheme Name | 2018 | 2017 | 2016 | 2015 | 2014 |
| Axis Midcap Fund(G) | 1 | 14 | 16 | 10 | 8 |
| Invesco India Midcap Fund(G) | 2 | 12 | 17 | 15 | 12 |
| Edelweiss Mid Cap Fund-Reg(G) | 3 | 6 | 13 | 1 | 12 |
| HDFC Mid-Cap Opportunities Fund(G) | 4 | 11 | 2 | 12 | 4 |
| Franklin India Prima Fund(G) | 5 | 13 | 1 | 11 | 9 |
| Motilal Oswal Midcap 30 Fund-Reg(G) | 6 | 16 | 9 | 15 | 12 |
| Kotak Emerging Equity Scheme(G) | 7 | 10 | 3 | 15 | 12 |
| DSP Midcap Fund-Reg(G) | 8 | 7 | 4 | 9 | 6 |
| UTI Mid Cap Fund-Reg(D) | 9 | 15 | 11 | 7 | 2 |
| ICICI Pru Midcap Fund(G) | 10 | 3 | 14 | 13 | 1 |
| L&T Midcap Fund-Reg(G) | 11 | 1 | 8 | 6 | 12 |
| Reliance Growth Fund(G) | 12 | 5 | 12 | 14 | 11 |
| Tata Mid Cap Growth Fund(G) | 13 | 4 | 15 | 3 | 5 |
| Sundaram Mid Cap Fund(G) | 14 | 8 | 6 | 5 | 7 |
| Aditya Birla SL Midcap Fund(G) | 15 | 2 | 7 | 4 | 10 |
| SBI Magnum Midcap Fund-Reg(G) | 16 | 17 | 5 | 2 | 3 |
| BNP Paribas Mid Cap Fund(G) | 17 | 9 | 10 | 8 | 12 |
Conclusion
When selecting mutual fund schemes, recent returns may look like an important parameter to evaluate fund houses but often that doesn’t work out for the best.
However, as shown above, its not the fund house’s absolute performance that should matter ( as that may change depending on market conditions and challenges) and instead, more importantly, its your comfort with the fund managers longer term performance as well as consistency that should play a role and therefore you should look at parameters that showcase this (PLMF Research Desks use Sharpe and Jensens Alpha ratios as indicative parameters to recommend schemes). Still no guarantee that you will still have the best funds of next year in your portfolio today – but its highly unlikely that you would have selected the worst!
Investors, like fund managers, should focus on consistency and predictability of returns rather than attempt to be top quartile performers all the time! That pays off in the longer term!
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