One should look at other parameters, too, before investing
If you are the type of investor who goes through the fact sheet or offer document before investing in a scheme, you would have come across a disclaimer (below the scheme's historical returns) stating, "past performance may or may not be sustained in future and should not be used as a basis for comparison with other investments."
Investors tend to make investments based on a scheme's past performance. To make matters worse, fund houses are only too pleased to toe the line by actively advertising the past performance of their schemes.
Is past performance the only parameter to be considered while investing in a mutual fund scheme? Not really.
Relevance of past performance
Past performance figures do not per se reveal certain critical points, some of which we'll discuss here:
*The risk the investor has been exposed to in the mutual fund's quest for growth. In a rising market, it is not altogether difficult to clock a higher growth if the fund manager is willing to take on higher risk (we have seen this on several occasions like the tech rally in 1999-2000, the mid cap rally in 2003-05). In that case, the past performance numbers in isolation will be inaccurate because they do not give investors any inkling of the higher risk they have been exposed to. Any investment must be evaluated based on the risk-return criterion.
*Even while showcasing past performance, funds are careful to show the compounded annualised growth rate (CAGR) numbers over longer time frames (3-5 years). Over this extended timeframe, a CAGR figure is not entirely representative of the ups and downs (which could be considerable given the extended time frame) witnessed by the mutual fund over that period.
A statistic that underlines how much a mutual fund has fallen during a particular market slump (as compared to the benchmark index and peers) or how it has performed during a particular calendar year is far more illustrative in our view as opposed to just a CAGR figure.
*It is possible that a fund has performed reasonably well (across relevant parameters) by itself, but hasn't quite made the mark when compared to its peers.
In other words, some of its peers that have outperformed it deserve to be considered by investors before the mutual fund under question. Hence, a comparison with its peers is necessary.
*Past performance often ignores the change in guard or mandate. Fund houses first talk of a star fund manager who was instrumental in sprucing up their performance. They get a lot of money based on this star fund manager.
The performance numbers that are advertised are attributed to the 'brilliance' of the star fund manager. When the star fund manager quits (which in many cases is often a matter of time), the fund house continues to use the performance attributable to the former fund manager to draw fresh monies under the new (star) fund manager.
What should investors do?
Our advice to investors is that they should adhere to the basics of mutual fund investing. They should evaluate mutual funds across parameters, including of course past performance, before considering any investment.
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