Most Investors find investing in the previous year's topperforming mutual funds a viable option, but is it? In this video, ETMONEY's Shankar Nath takes you through a datarich study to understand how practical and profitable is this modernday practice of selecting the best mutual funds of yesteryears under the assumption that they will continue to achieve their previous glories.

What's covered in this video?
00:00 Introduction
00:45 Chasing Past Glories & Outcome Bias
02:26 ETMONEY Study
09:11 Two More Scenarios
11:52 How Not to Chase Performance

CHASING PAST GLORIES AND THE OUTCOME BIAS

Past performance is no guarantee of future results. We've heard this before and it won't be wrong to say that each of us understands that future mutual fund performance is impossible to predict. And yet, tens of thousands of mutual fund investors operate under the powerful grips of an outcome bias.

An outcome bias arises when a decision is based on the outcome of previous events, without any regard to how those past events developed. This distortion of the truth creates a situation where when a good decision goes bad, it is promptly treated as a sign of poor decision making. And if a potentially wrong decision turns positive although it might be pure luck, it is treated as a sign of superior decision making.

It is this distorted view of reality that often leads to many investors to become performance chasers, which means they often sell their holdings in slow performing mutual funds and reinvest the proceeds into recent winners.

ETMONEY STUDY

We shortlisted 75 mutual funds that had at least 10 years of performance history under their belt and a minimum AUM of ₹500 crores. We ranked these mutual funds according to the returns generated by these schemes.

We looked at the following 6 scenarios:

Scenarios 1 how would a portfolio have performed if one were to buy only the top 3 funds every year? This strategy of chasing the top 3 rankers of every year for the last 9 years, gives us an annualized return of 12.6%.

Scenario 2 how would a portfolio have performed if one were to buy funds that were ranked 25th, 26th and 27th? This strategy of chasing the high mid rankers would have yielded an annualized returns of 9.5%.

Scenario 3 how would a portfolio have performed if one were to buy funds that were ranked 50th, 51st and 52nd? This strategy of investing in the previous year's low mid rankers would have delivered an annual returns of 9.3%.

Scenario 4 how would a portfolio have performed if one were to buy funds that were ranked 73rd, 74th and 75th? (i.e. the lowest ranked funds). This strategy would, surprisingly, have done quite well and would have delivered an annualized return of 10.9%

Scenario 5 Now, in real life, many investors tend to have a trading mentality i.e. they frequently buy and sell mutual funds at the click of a button. The scenario we are studying here is if we buy ranks 1, 2, or 3 … and we sell as soon as the fund gets ranked below the midpoint i.e. the scheme is ranked 40 or below. In other words, we buy when the rank is high and we sell when the ranking goes below the midpoint. We computed that this buysell practice did not yield much of a gain with an XIRR of 12.9%.

Scenario 6 In this final scenario, we simply invest in an index fund rather than an actively managed fund. The benchmark of choice here is the Nifty 200 TRI. This strategy would have given an annualized return of 12.2%

HOW TO REDUCE BEST MUTUAL FUNDS PERFORMANCE CHASING

We spoke about three simple yet effective tips that one can apply starting today and which’ll go a long way in improving your investing practices.

Tip 1 Realize the realities of investing

Remember, the world’s best investors recognize that they are as likely to make mistakes in their stock selection.

Tip 2 Add more filters in your mutual fund selection.

Performance is one variable. There are many more variables one should look at which includes risk scores, fund volatility, its consistency, benchmark performance, category performance etc. A great way to do this is to use the ETMONEY Ranking and Rating feature that is available for all schemes.

Tip 3 Go for passive investing through index funds.

Index funds ensure that you are always achieving benchmark returns and dont have to worry about the changing and tracking different mutual funds.

Video Credit :
The Art of Investing | François Rochon | Talks at Google
   • The Art of Investing | François Roch...  

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