Last Updated on April 28, 2016 at 6:42 am
If I choose a fund with a solid track record, what are the chances that it would deliver in future? Does past performance matter? This is a question on the minds of most mutual fund investors. Let us try and answer this question using annual returns of all diversified equity funds from Value Research.
This post was first published on April 10th 2015. I have now included updated results. The text in brown has been added now.
Value Research provides annual returns for the last 12 years (as of this moment. It can be temperamental!). So I have calculated the CAGR of the first 6 years and plotted it against the CAGR of the next 6 years.
I recognize the results of such analysis could depend on the duration chosen (and it is!) . It can also depend on market movements.
Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email! 🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥
Results based on annual returns from 2003-2014
Notice that the data points slope upwards from left to right. So the correlation between past and future is non-zero.
The rectangle represents all funds within one standard deviation, either side of the average for the first 6 years (length of the rectangle) and for the next 6 (breadth of the rectangle).
A good 48% of funds are inside the box (34 out of 71 funds). That is, if the first 6 year CAGR was within one standard deviation from the average, there is a 48% chance that the next 6 year CAGR will also be within one standard deviation from the average.
Or speaking in terms of star ratings, using VR online’s methodology, a fund rated 3-star or 4-star after the first 6 years has 48% chances of being rated a 3-star or 4-star fund after the next 6 years.
It is also seen that 1-star or 2-star based on first 6 years performance ( points to the left of the rectangle) has a high probability of being rated the same after the next 6 years.
This means that past performance does have a significant influence on future performance for the data set studied.
The problem is only with 5-star funds. A fund rate 5-star after the first 6 years can just about be rated anything after the next 6-years.
Results based on annual returns from 2004-2015
Now 48 out of 95 funds are within the rectangle. That is ~ 50%. So the general conclusions made above are still valid. In fact, in this window some of the top performers over the first six years (to left of the box) have continued to do well in the next six.
Many average performent in the first six (funds above the box) have gone on to become top performents in the next six.
However, the boundaries of the box have changed greatly!
2003-2014
first six years: 18% – 31%
next six years: 18% -26%
They had a common lower bound which is purely accidental.
2004-2015
first six years: 16% – 27%
next six years: 7% -13% (that is huge downward shift!)
Yet another example of how volatile equity can be! Nonetheless, the central observation from this analysis is,
Funds with a ‘reasonable’ history of past performance have a pretty decent shot at reproducing that in future. Reasonable here refers to within one standard deviation of the average.
Or in other words, average performers have at least a 50% chance of remaining an average performer in future. Seems obvious when backed with some data! Now, this sounds terrible! However, for investors who want minimum maintenance portfolios, this is good news. While screening for mutual funds, they can cast a wide net (eg. average and above performance)
Investors who crave to be invested in the ‘best’ funds, will have to churn, perhaps frequently, in order to satisfy their craving.
Corollary: Expecting less from equity allows me (and Ashal Jauhari) to invest calmly with peace of mind and more importantly lower (not zero) portfolio management.
Read more: Understanding the nature of stock market returns
🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! ⇐ More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
- Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
- Have a question? Subscribe to our newsletter using the form below.
- Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.
Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
About The Author
Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course! Increase your income by getting people to pay for your skills! ⇐ More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
- Twitter @freefincal
- Subscribe to our YouTube Videos
- Posts feed via Feedburner.
Our publications
You Can Be Rich Too with Goal-Based Investing
Published by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
This book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.Your Ultimate Guide to Travel
This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)