MF QueryBoard

I have been a Mutual Fund investor for many years and have often noticed that once top-ranked funds tend to underperform later. Could you explain why this happens? - Kamlendra P. 

This is one of the most common and most misunderstood observations in mutual fund investing. A fund that tops performance charts in one phase often struggles in the next, and this happens due to structural reasons rather than fund manager incompetence. Markets move in cycles. At any point, a specific investment style leads the rally. Sometimes Large-Cap stocks dominate, sometimes mid and Small-Caps surge, and at other times value stocks outperform growth stocks. A fund rises to the top when its style matches the prevailing market environment. 

However, cycles do not last forever. When market leadership shifts, yesterday’s winner naturally loses its edge. Another important reason is portfolio positioning. To generate superior returns, a fund usually takes relatively higher exposure to a particular sector, market cap segment, or investment theme. T his concentration helps the fund outperform in favourable conditions, but the same positioning becomes a disadvantage when the cycle turns. The fund does not suddenly become bad. T he environment simply stops favouring its strategy. Large inflows also play a role. After strong performance, investors pour money into the fund. 

Managing a much larger asset base makes it harder for the fund manager to invest in smaller, high conviction opportunities, especially in mid and small-cap stocks. The portfolio becomes more diversified and more similar to the benchmark, which reduces excess returns. There is also the concept of mean reversion. Extremely high returns are rarely sustainable for long periods. 

Over time, performance tends to move closer to market averages. Therefore, investors should not chase rankings. Instead, they should select funds based on consistency, risk control, and suitability to their asset allocation rather than recent past returns. 

I have come across the term ‘rolling returns’ several times in your stories. Could you please explain what rolling returns mean in mutual fund performance evaluation? - Sanchi Parmar 

Rolling returns are one of the most reliable ways to evaluate mutual fund performance, yet they are less commonly understood by investors. Most investors judge a fund using point-to-point returns such as three-year or f ive-year returns calculated between two specific dates. This method can be misleading because the result depends heavily on the starting and ending market levels. Rolling returns remove this timing bias. Instead of calculating return only once, the fund’s return is calculated repeatedly for overlapping periods. 

For example, in a five-year rolling return analysis, the five-year return is calculated for every day or every month across a long-time span. This produces hundreds of observations rather than a single number. This approach shows how consistently a fund has performed across different market phases such as bull markets, corrections, and sideways periods. 

A fund may show an attractive five-year point to point return simply because it started from a market bottom. However, rolling returns reveal whether the fund delivered good performance regardless of when an investor entered. 

Rolling returns also help investors judge reliability. If a fund frequently beats its benchmark across most periods, it indicates a robust investment process. If performance is good only in a few scattered phases, the fund is more dependent on favourable market conditions. They also help evaluate downside protection. During falling markets, rolling returns clearly show whether the fund limited losses compared with peers and the benchmark. Therefore, instead of focusing only on recent returns or rankings, investors should prefer funds that demonstrate stable and consistent rolling return performance across multiple market cycles.