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The Efficacy of Past Performance Analysis of Mutual Funds

Yesterday a student doing some project on Mutual Fund Performance Analysis, reached out to me for sharing my inputs. While replying to her, I felt this is in fact the matter of the title of this article – Efficacy of Performance Analysis. For me, actually this is a frequently faced question or situation, though not in exact words; clients, prospects and DIY investors seeking ‘little help’ (is that ‘DIY’?!) want a hack of choosing winners by looking at past performance. Investment comparison portals kind of make it more attractive and look easy-peasy task by giving “Star” ratings to schemes based on past performance.
I am just reproducing my reply letter to her.

Dear Sister,

The title of your project “Performance Analysis of selected Mutual Funds as an Investing vehicle for an Individualitself, and hence the set of objectives, is put together inappropriately. Performance analysis should not be the basis (at least primary or main basis) for Mutual Funds being investment vehicles of an individual. Unfortunately this is the mistake most people (self service investors, DIY Investors and even amateur professionals) do and fail themselves in investing and more often than not, will have bitter experience with MF investing.

While choosing an investment vehicle in general and very more importantly so in mutual funds, one should consider his/er financial goals and risk tolerance.
  • Financial Goals primarily give the purpose to the investments and help to determine the investment horizon (duration) of investment – which is one of the very important parameters in determining appropriate risk to be taken on investment portfolio for the specific goal.
  • Risk Tolerance assessment has to be done on three parameters of an individual’s situation – Affordability, Willingness and the Need. ‘Affordability’ to take investment risk is based on factual things such as Age, Income, Family Demography, Investing Knowledge & Experience etc of an individual; ‘Willingness’ is mental (psychological) readiness towards investment risks (potential volatility and losses); ‘Need’ is again based on factual situation relative to the individual like his/er Financial and Life Stage Status, Personal Investment objective, Needed Rate of Return etc.

Once investor is clear on above things s/he effectively and rationally derives ‘Investment Horizon’ and ‘Risk Tolerance’ which helps in formulating appropriate Asset Allocation and Scheme Categories. ‘Asset Allocation’ is determining the mix (ratios) of asset classes like Debt, Equity and Gold. ‘Scheme Categories’ are broader classification of Mutual Fund schemes based on Sub-classes of assets. Each of Equity and Debt asset classes will have sub-classes within themselves based on specific characteristic variants of each asset class. Then the last step is Investment Analysis within the Chosen Scheme Category.

You should understand that if an investor has done meticulous job of first things, which is easier part, and done a bad job at last & difficult part (investment analysis), s/he will be far better off than person doing other way round. Investment Analysis is relatively complex subject that requires education, research and acumen, developed over years of experience. So, there is no simple template or trick or magic / secret formula that I can give you.

However, here are few simple (and effective) things to consider while doing investment analysis (or simply put, guidelines to pick funds). In fact you can google and get more sophisticated ones.
  • If you are choosing scheme under equity asset class,  for a long term goal, you better look for a scheme with good parentage (the one belongs to well-known name / brand) and lineage (long track record). Reputed Investment managers with good resources and capabilities are expected to do well over long periods to ensure their reputation and the longer track record gives the confidence that the scheme has seasoned & withered the changes in the market, cycles and fund managers – which means  it has got its investment process.
  • You better choose Equity Multicap category for your long term goals than specific Large, Mid or Small Cap.
  • Aggressive Hybrid is great a category for Someone with more than 5 years investment horizon and slightly fearful of stock market or first time Equity MF investor; be mindful that equity portion of the hybrid fund is managed like a Multicap fund.
  • Consider Pure Midcap and Small Cap Funds if you can at least somewhat understand Market Cycles and somewhat choose your entry and exit points.
  • Avoid Thematic and Sectoral Funds, unless you have deep understanding & intuition developed by close observation and years of experience about economy, market cycles and specific sector/s.
  • At more advanced level, for Equity Mutual Funds, you may look at Standard Deviation, Sharpe Ratio, Beta, Portfolio Turnover Ratio, TER, Detailed Portfolio Holdings, etc , if you can interpret and make sense out of that information.
  • Consider Short Term Debt Mutual Funds for your Short term goals over any other popular & traditional fixed income products
  • Consider High Quality, Medium Term, Corporate Debt Funds if you are conservative and have medium term investment horizon or as debt allocation of your long term portfolio
  • Avoid Credit Risk Funds if you can't understand Credit Quality and Ratings of the papers in the Scheme's portfolio
  • Avoid Long Term Debt and Gilt Funds if you are not knowledgeable enough to interpret economical indicators and can’t estimate the direction of interest rate cycle and yield curve. For pure long term allocation to Long Term Debt (as part of your long term portfolio) you may consider PPF if feasible or Gilt Funds if you can remain undisturbed by NAV fluctuation.
  • At more advanced level, for Debt Mutual Funds, you may look at Modified Duration, YTM, TER, Average Quality of the Paper, Detailed Holdings in the Portfolio etc, if you can interpret and make sense out of that information.

Further, if you are expecting me to give a process flow how to select an MF based on deep analysis and comparison of various schemes’ past performance across different time periods or the methods of comparing past performance, I am sorry, I am of the opinion that they are of only academic interest with almost zero practical utility. I am a practicing professional and not an academician.

I believe deep analysis of past performance for taking tactical investment decisions in Stocks (shares) of specific companies or Mutual Funds Schemes is a futile attempt; however, that is perhaps a good strategy to employ if you are considering Index or ETF (Passive Mutual Funds) investing. It may be practical to do such deep past analysis on Indices because indices are designed to choose constituent stocks based on pre-defined rules and all the time the portfolio of stocks in the Indices are the ones which fulfilled those rules. In future also, Indices will continue to have the stocks that will fulfil those rules of specific indices. However, the performance of an individual stock (company) is more importantly based on Management Competence & Expertise, Economy, Market Cycles & Dynamics (about that company’s products & services), Govt Policies Concerning that particular sector, etc, which are not uniform across different time periods, for which you wish to study the price movement & performance of that company’s share on stock market. Similarly an Actively Managed Fund’s performance also depends more on Fund Manager & his/er team’s view / outlook, Style, trends in Economy, Govt policies, Consumer Demography & Preferences, International Business Environment etc which are not uniform across the different time periods of your interest, across which you wish to compare the NAV or performance of the scheme/s.

With all that, I do not mean Past Performance analysis is useless; but it is useful only if it is done in the light of other variables I mentioned above. Doing that makes it far more complex activity than just a spreadsheet number-crunching routine. Your interest in the investments is in the results that they are going to produce in the future, irrespective of their past performance. So, you should estimate (or even guesstimate) likely future circumstances / trends and check in the past how and which investments fared well in the past during similar circumstances. I am fully aware that having an opinion about future circumstance is like gazing the crystal ball but that’s the wisdom one would develop over a period of passionate learning and experience.

Perhaps you didn’t get the inputs you were expecting, or at least not to your satisfaction and the extent needed for your project. In fact, as I said in the beginning, many people think and try doing like the title of your project while investing in Equity & Equity MF’s. That’s a very downside-up approach.

Thanks for giving me this opportunity and making me write-down my thoughts about this subject, which now is available for me to share with anyone coming to me asking for process of choosing ‘best’ MF schemes.


  1. Informative article.

    This article is about analyzing the past data to choose correct MF for investment. Are there any other indicators other than CAGR to analyze the performance of existing MF investments? what corrective actions do these indicators suggest for existing investments?


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