Should mutual fund investors always invest in toppers?
According to mutual fund managers and advisors, most investors don’t look beyond the top five funds in the performance chart. Most of them don’t look beyond the performance of one or two years, even when choosing stock mutual funds. This could explain why these investors are asking this question.
The first step is to understand how these performance charts are created. Typically, many charts use simple returns for short periods, say a year. If greater than three years, the returns would be a Compound Annual Growth Rate or CAGR. If they track star ratings, you will find that the top quartile or 25% get 5 star ratings. The second quartile gets 4 stars, the third quartile gets 3 stars, and so on.
Does that tell you anything about the diet? Of course, this tells you how well a program has performed over a period of time. It also tells you how the program performed in the category. However, the performance can be skewed due to a good year. Or the regime had a big race in the past.
This brings us to the usefulness of performance charts. The plan’s performance is based on its past performance. It can in no way assume that past performance will continue. This is why mutual funds are required to disclose that past performance may or may not be repeated. If so, should you place too much emphasis on the high end in the performance chart?
According to mutual fund analysts, investors can use these charts as a good starting point. Beyond that they have no value, say these advisers. They say that if a system is above average (meaning it is in the top 50%), investors need not worry about its performance. Some advisors and fund managers say investors can look at the program’s performance over calendar years – if the program managed to run six or seven years in a decade, you should be happy. Pay attention to flash in panoramic performances.
No matter how hard you try, your diet won’t make the top five quarter after quarter or year after year. A fund manager may make certain calls during a given period depending on their market outlook. Sometimes certain calls will be wrong or the market may take time to recognize them. In such periods, the program may not be among the best. But when a call turns out to be right, the program will be generously rewarded. If you jumped on another topper, you would miss those extra returns. Also, if the schematic has a bad patch, you will switch to another schematic. That’s why fund managers say such a quest will ultimately prove futile.