Are You Picking the Wrong Funds?

Every mutual fund looks good on paper until markets shift or performance slips. Markets change. Managers change. But investors often don’t. Many investors get lured by flashy themes, past returns, or star managers. Few pause to ask: Is this fund right for me? Mandar Wagh explains how to avoid missteps and build a fund portfolio that actually suits you [EasyDNNnews:PaidContentStart]

When Saurabh, a 30-year-old IT professional from Pune, started investing in mutual funds in 2022, he did what many new investors do. He opened a popular app, clicked on ‘Top Performing Funds,’ and put ₹5 lakhs in a sectoral fund that had delivered more than 45 per cent returns in the previous year. The fund focused on emerging technology stocks. Fast forward to mid-2024, and Saurabh was staring at a 20 per cent drawdown. His mistake? Chasing performance without assessing the fund’s suitability for his goals or the risk factors that could affect its performance 

Unfortunately, Saurabh is not alone. Many investors, particularly those who are new to mutual funds or influenced by the buzz around hot themes, fall into the trap of picking the wrong funds. Not because the funds are inherently bad, but because they’re wrong for their needs, their goals, or the current stage of the market cycle. Let’s break down why that happens, and more importantly, how you can avoid being in that position. 

1. The Return Trap: Past Performance ≠ Future Promise 

The most common mistake investors make is chasing past returns. Who wouldn’t want to put money into a fund that delivered 45 per cent last year? But what’s often missed is how that return was generated. Was it a one-off event? A sectorspecific boom? Or a risky bet that just happened to work out? Consider the defence sector funds that turned heads in early 2024 with year-to-date gains of 40-50 per cent. Many investors piled in, assuming the rally had more legs. 

But in the second half of the year, these funds witnessed a sharp correction, some falling as much as 30 per cent, even as the broader Nifty 50 fell only 3-4 per cent. This stark contrast highlights why blindly following top-performer lists can be dangerous. Consider infrastructure funds during the 2008 period. Investors seeking opportunities in the segment were hit hard as defaults and liquidity shocks triggered a steep fall, catching many off guard. 

Better Strategy 

Rather than focusing solely on returns, investors should assess how consistently those returns are delivered across market cycles. A fund may outperform its benchmark in a given year, but was that outperformance steady or driven by short-term market trends? This is where the Information Ratio becomes valuable. It measures the fund’s active return relative to its tracking error, indicating how efficiently and consistently the fund manager has generated excess returns. A higher Information Ratio suggests skilful and repeatable performance with controlled risk, while a lower ratio may point to volatility or luck-driven gains. 

2. The Mismatch Between Fund Type and Financial Goal 

Just as you wouldn’t use a two-wheeler for a cross-country trip, you shouldn’t use a liquid fund for retirement planning or a Small-Cap fund for your emergency corpus. But surprisingly, this misalignment happens frequently. A 28-year-old investor planning to buy a car in two years may choose an aggressive equity fund based on high past returns, only to realise later that short-term equity investing is a risky bet. On the other hand, someone planning for retirement 25 years away might be sitting in a low-yield hybrid or Debt Fund, missing out on the compounding power of equities. 

Better Strategy 

It’s important to align your fund type with your investment horizon and risk appetite. For periods of less than a year, consider liquid or ultra-short-term debt funds that offer stability with minimal risk. If your horizon is 1 to 3 years, low-duration or short-term debt funds may be suitable. For medium-term goals spanning 3 to 5 years, conservative Hybrid Funds or balanced advantage funds provide a balanced mix of debt and equity. For long-term goals beyond 5 years, diversified equity or index funds are ideal, offering growth potential to beat inflation and build wealth over time. 

3. Falling for Sectoral or Thematic Lures 

Sectoral and thematic funds often flash high returns during their boom phase. But they are also the first to fall when the sentiment reverses. Whether it’s electric vehicles, defence, renewable energy or infrastructure, thematic funds can be highly volatile and they require active monitoring and entry-exit timing skills. Moreover, these funds usually have a narrow portfolio and are concentrated bets, which is fine for seasoned investors but risky for new or casual investors. Investors who jumped into IT sector funds during the 2020-21 technology boom saw massive early gains. But by 2022 and early 2023, IT stocks had a global correction due to weak demand, reduced spending and margin pressure, and these funds delivered muted or negative returns. 

Better Strategy 

A better approach is to treat sectoral and thematic funds as satellite holdings instead of core portfolio components. Limit exposure to a small portion of your total investments, ideally not more than 10 to 15 per cent. Use them to express specific convictions, but only after understanding their risks, narrow focus, and potential volatility. They should be actively managed. For most investors who do not have time and expertise to this, diversified or flexi-cap funds through SIPs offer a more stable and consistent path to long-term wealth creation. 

4. Ignoring Market Cycles and Risk Metrics 

Many funds look good in bull markets because everything rises in a tide. But only a handful stand out in tough times. Judging a fund only by its bull market returns is like rating a cricket player solely on flat-pitch batting. A better indicator is how the fund performs across market cycles, both up and down. Has it managed to limit downside? How volatile has it been? Did it beat its benchmark consistently? A fund’s resilience and ability to deliver through different market phases matter more than short-term outperformance. Investing without considering market cycles or relying solely on past bull-run data can lead to disappointment. Look for consistency, risk control, and adaptability rather than temporary highs. 

Better Strategy 

A better approach is to assess a fund’s performance across both bull and bear markets, not just during rallies. Unfortunately, many investors shy away from technical metrics like Sharpe ratio, Alpha, or Beta, thinking they’re too complicated. But these tell you whether the risk taken was worth the return. Understanding these indicators helps separate genuinely skilful fund managers from those who simply rode a market wave. Long-term success lies in balanced, risk-adjusted performance. 

5. Overlooking Expense Ratios and Portfolio Churn 

Two funds may report similar gross returns, but your actual gains can differ significantly depending on factors like expense ratio and portfolio turnover. If a fund has higher costs or excessive buying and selling, your net returns take a hit. This is particularly relevant in actively managed small and Mid-Cap funds, where frequent churn is common. Each transaction, even if not visible to you, carries hidden costs such as brokerage and taxes. Over time, these can erode the fund’s performance and reduce investor wealth. 

Better Strategy 

A better strategy is to look beyond gross returns and focus on net, risk-adjusted performance. Choose funds with reasonable expense ratios and low portfolio turnover, especially in the small and mid-cap category where costs can quietly eat into gains. A buy-and-hold strategy with a consistent approach often outperforms frequent churning. Reviewing fund factsheets for turnover ratio and expense details helps you make informed decisions. Over the long term, controlling costs is as important as chasing returns. 

6. Chasing New Fund Offers (NFOs) and Buzzwords 

New Fund Offers often hit the market with catchy themes like ‘XYZ Golden Opportunities Fund,’ glossy brochures, and star fund 

managers. But remember, a new fund has no track record, no tested performance, and no history of risk management. While some NFOs do well, the success rate is unpredictable. Moreover, many NFOs are launched simply to capitalise on current themes or trends. 

Better Strategy 

Investors should evaluate whether the NFO aligns with their investment horizon, risk appetite, and financial goals. If it fits, they can consider taking advantage of the new opportunity. Otherwise, it’s wiser to prioritise existing funds with a solid track record, as they offer greater transparency, proven strategies, and measurable risk management. 

7. Lack of Periodic Review and Portfolio Clean-up 

Investing in a fund is not a one-time decision. A fund that performed well two years ago may not deliver the same results today, as strategies shift, fund managers change, and market conditions evolve. Yet many investors adopt a ‘set it and forget it’ approach. A fund that once ranked in the top quartile can easily slip to the bottom. Holding on due to sentiment or inertia can hinder long-term wealth creation. Regularly reviewing and rebalancing your portfolio ensures it stays aligned with your goals and adapts to changing market dynamics. 

Better Strategy 

Review your mutual fund portfolio at least once a year to ensure it stays on track. Watch out for persistent underperformance compared to the benchmark and category average. Also, check for style drift, which occurs when a fund strays from its original mandate, and any changes in fund manager or investment strategy. Such shifts can impact future returns. If a fund has consistently underdelivered for around six quarters despite market recovery or peers doing better, do not hesitate to exit and switch to a better-performing option aligned with your goals and risk profile. 

Final Thoughts

The biggest truth in mutual fund investing is this. Markets change, fund managers rotate, and themes fade, but a well-chosen, well-reviewed portfolio stands the test of time. There’s no best fund, only a best-fit fund for your needs. What works for your friend or a social media influencer might not work for you. Mutual fund investing is not about chasing fads. It’s about aligning your investments to your goals, time horizon, and risk appetite. Instead of picking funds based on buzz, start with your goals. Are you saving for a home in five years? 

Planning for your child’s education 15 years away? Want to build an emergency fund or plan for early retirement? Each goal demands a different approach, and there’s a suitable fund category for every need. And yes, past performance does matter, but only when seen in context, alongside volatility, consistency, and suitability. Avoiding the wrong fund is not just about avoiding poor performance. It’s about maximising long-term success. Choose wisely, invest consistently, and review regularly. That’s the real formula for mutual fund wealth creation. 

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