Past Mutual Fund Performance Doesn’t Tell You The Real Story—Here's Why
A top-performing fund is often a reflection of the last market cycle, not a guarantee of future consistency.
When most of us start investing, we are told one simple rule: See the historical or past performance.
If it’s a stock, we open up the company’s history and financials.
a. We look at how sales and profits have grown over the last few years, how margins moved, what the balance sheet looks like and what the ratios are saying.
b. Only after seeing this track record do we feel comfortable investing.
If it’s a mutual fund, we do something similar in our own way.
a. We scroll through the app, check 1-year, 3-year, 5-year and 10-year returns, see which funds are in the top 10 and then shortlist the ones that look the best on past performance.
On paper, it feels like we’re doing the same thing in both cases:
Study the past and then decide for the future. But here is where the story changes.
In stocks, past numbers often tell you how the business has actually grown. In mutual funds, past returns mostly tell you how the market cycle behaved in that period.
Does history always repeat itself? Is past performance a promise for future return at all? Do your top funds always remain in the top?
Let’s break this down:
A research that we did for the 1 Finance Magazine found that funds that rank in the top 10 for a 3-year period often fall out of even the top 100 in the next three years.
Not because the fund manager suddenly forgot how to manage money. Not because the fund became bad overnight. But because the market environment and cycles changed, the positioning that helped earlier is not working now.
This one data point is enough to shake our comfort with the usual past-return-based fund selection.
Why Don’t Top-Performing Funds Stay on Top?
You don’t need complicated theory to understand why this happens. A few simple ideas explain most of it.
1. Sectors move in cycles
Think about phases when IT, PSUs, small caps or banking did exceptionally well. Any fund that was overweight on the sector in favour during that phase would naturally appear right at the top of the performance tables.
But when the cycle turned, the very same funds slipped sharply in rankings, not due to lack of skill, but because the cycle that helped them reversed.
The Nifty IT Index did well around 2021–22, but after that it corrected sharply and is still around previous highs. It doesn’t move in a straight line; it moves in phases.
Nifty Media made an all-time high in 2018, but ever since, it has not even been able to reclaim the highs made eight years back. That’s why these indices can stay flat (or even down) for long periods.
2. Themes don’t stay powerful forever
Many standout performers are often theme-heavy:
Small-cap tilted funds
PSU or infra-heavy funds
Sector-biased funds (like IT or pharma)
They look brilliant in one market phase and very ordinary in the next. The earlier outperformance came from a theme, not a permanent edge.
3. Size changes how a fund behaves
When a fund attracts a lot of money after a good phase, it becomes very large. Once that happens, it gets harder to:
take concentrated bets
move in and out of positions
stay very different from the index
Slowly, many large funds start behaving more like the index, and the earlier “extra” return fades.
What This Means for Investors?
The key takeaway from the study is simple:
A top-performing fund is often a reflection of the last market cycle, not a guarantee of future consistency.
So, how do you look at funds instead?
You don’t have to ignore performance. You just have to read it differently.
1. Look for consistency, not one-off spikes
A fund that quietly stays in a reasonable band across cycles, not top 10, but also not crashing to the bottom, is often a healthier choice than a fund that jumps from rank 1 to rank 150 and back.
Rather than past returns, some of these quantitative parameters can be used:
Standard Deviation: Shows how volatile the fund is.
Sharpe Ratio: Measures return earned per unit of total risk; higher is better.
Sortino Ratio: Measures return per unit of downside risk; higher is better.
Maximum Drawdown: Shows the worst fall from peak to bottom; helps judge downside pain.
Alpha: Shows excess return over the benchmark (after adjusting for risk); higher is better.
Consistency is usually a sign of process and risk control, not luck.
2. Always ask: What is driving this performance?
If a fund has outperformed, try to understand why:
Is it because of a big tilt to small caps?
Is it loaded with PSUs after a PSU rally?
Is it heavily biased towards one hot sector?
Is it taking high-conviction, concentrated bets?
If the answer is mostly thematic, then the “outperformance” is likely to be temporary. Once the theme runs its course, the ranking will adjust accordingly.
This one habit, checking what the fund holds instead of just how it did, can prevent a lot of disappointment later.
Disclaimer: The views expressed in this article are solely those of the author and do not necessarily reflect the opinion of NDTV Profit or its affiliates. Readers are advised to conduct their own research or consult a qualified professional before making any investment or business decisions. NDTV Profit does not guarantee the accuracy, completeness, or reliability of the information presented in this article.
