MUTUAL FUND ANALYSIS  ·  INVESTOR EDUCATION

A field guide to mutual fund returns: luck, skill, costs and the arithmetic of compounding, with evidence from Indian funds.

THE REAR-VIEW MIRROR

Every mutual fund investor has done it: sorted a category by five-year returns, picked from the top of the column, and quietly assumed the next five years would look the same.

It is among the most natural instincts in investing, and one of the most expensive. This guide explains why a strong fund record so often fails to repeat, using data from India’s own fund market, arithmetic you can check yourself, and a short checklist you can use before your next SIP or lump sum.

Nothing here is meant to make you cynical about returns. It is meant to make you precise about what a fund’s return can and cannot tell you.

IN THIS READING

01 The photograph and the film

02 Luck wears the costume of skill

03 Regression to the mean

04 The ground shifts beneath the fund

05 The arithmetic that fools averages

06 The graveyard you never see

07 Costs compound quietly

08 What the scorecards say

09 The behaviour gap

10 What past returns are good for

→ Your pre-investment checklist

01 The photograph and the film

A fund’s past return is a photograph of a journey already taken. It shows where the fund ended up. It says very little about the road, the weather or the driver.

A fund that compounded at 28% a year for five years did not earn that figure by a law of nature. It earned it in a particular market, under particular interest rates, with a particular manager making particular calls, some wise and some lucky. The next five years will have different weather, different traffic and, often, a different fund manager.

This is why every mutual fund advertisement in India carries the line that past performance may or may not be sustained in future. It reads like boilerplate. It is in fact the single best-supported sentence in all of investing.

Core idea A past return describes what happened. A future return depends on what happens next. The two are connected, but far more loosely than our instincts insist.

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02 Luck wears the costume of skill

Imagine 1,000 fund managers who each choose their portfolio by flipping a coin every January. Heads beats the benchmark that year. Tails lags it. Nobody has any skill; the outcome is pure chance.

After one year, about 500 have outperformed. After two, about 250. After five years, the arithmetic of halving leaves a small and very impressive group.

31 managers out of 1,000 would show five straight years of outperformance, purely by chance (1,000 ÷ 32).

Those 31 funds would be featured, ranked and rated. Their five-year numbers would head every league table. And not one of them would be any more likely than the rest to win in year six.

Real fund managers are not coin flips; genuine skill exists. But the lesson holds. With so many schemes competing in every category, some fund is always on a streak, and a streak is exactly what luck produces in a large crowd. The question is never “did it win?” It is “was winning repeatable, and why?”

In a big enough crowd, luck looks exactly like genius.

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03 Regression to the mean

Extreme results tend to be followed by more ordinary ones. Statisticians call this regression to the mean, and it is the quiet engine behind most disappointed fund investors.

The reason is simple. Any fund return has two ingredients. One is durable: a sound process, a sensible portfolio, low costs. The other is temporary: a sector or theme suddenly in fashion, a concentrated bet that paid off, a rally that lifted everything. The durable part carries forward. The temporary part fades, and the more extreme the result, the more of it was probably temporary.

Example S&P’s Persistence Scorecard follows US funds that ranked in the top quartile of their category in 2021. By the end of 2025, fewer than 1% of domestic equity funds were still in the top quartile, and not a single mid-cap fund had held on.

Example In S&P’s SPIVA India scorecard for 2025, five of the six sectors that had beaten the benchmark in 2024 trailed it in 2025. A fund that earned its ranking by leaning on one hot sector inherits that reversal.

To be fair, the scorecards show some short-run persistence. About 29% of top-quartile US large-cap funds from 2023 were still there two years later. But over five years the picture collapses. A good run is a reason to look closer, not a forecast.

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04 The ground shifts beneath the fund

Every fund earns its returns inside a set of conditions: interest rates, valuations, liquidity, sentiment, regulation. When those conditions change, the fund’s past record becomes a record of a world that no longer exists.

−52% was the Nifty 50’s calendar-year return in 2008, followed by about +76% in 2009.

An investor who had studied the glowing five-year record of an equity fund in 2007 learned nothing about 2008. An investor who studied the carnage of 2008 learned nothing about 2009. Both were looking at the mirror while the road turned.

Japan offers the most dramatic example. Its Nikkei 225 index peaked in December 1989 and did not close above that level again until February 2024, more than thirty-four years later. A Japan fund bought on the strength of its 1980s record was not slightly wrong. It was wrong for a generation.

Debt funds The same trap catches debt funds. A strong record earned while interest rates were falling includes price gains that cannot repeat when rates rise. The past yield and the future yield are answers to different questions.

Takeaway Ask not only “what did the fund return?” but “what had to be true for it to return that?” If the answer is a condition that can change, the record can too.

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05 The arithmetic that fools averages

Returns do not add. They multiply, and that single fact turns many impressive-sounding numbers into something less impressive.

Suppose you hold ₹100 in a fund. It rises 50% to ₹150. Then it falls 50% to ₹75. The “average” return is zero, but you have lost a quarter of your money. A 50% loss needs a 100% gain just to recover.

Now take a fund with three calendar years of returns of +80%, −40% and +30%. Its simple average is 23.3% a year. That is the number a pitch might proudly quote. But ₹100 becomes ₹180, then ₹108, then ₹140.4.

12.0% is the compounded annual return (CAGR) actually earned, barely half the 23.3% “average”.

This matters for prediction too. Highly volatile funds are the ones that most flatter their own averages, and the ones in which a single great year carries the whole story. When you compare funds, look at CAGR over full periods, not the average of yearly figures.

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06 The graveyard you never see

When you sort funds by past returns, you are sorting the survivors. Funds that perform badly are quietly closed or merged into stronger siblings, and their records disappear from the list. What remains looks better than the whole population ever was.

This is survivorship bias, and it flatters every ranking you have ever seen. It is why serious scorecards, including SPIVA, deliberately count the funds that closed or merged along the way. The Persistence Scorecard finds the pattern clearly: bottom-quartile US equity funds were more than twice as likely to be merged or liquidated within five years as top-quartile ones, about 23% against 10%.

Example In April 2020, Franklin Templeton India wound up six debt schemes after high-yield credit holdings became hard to sell. Part of what their past returns had been paying for was a risk that surfaced later.

You cannot learn what predicts success by studying only the funds that survived.

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07 Costs compound quietly

If gross returns are uncertain, costs are not. They are deducted every year, whatever the market does, and like returns they compound. This is the one part of the equation you can see in advance.

In India, a regular plan and a direct plan of the same scheme hold the same portfolio under the same manager. The difference is distribution cost: a regular plan pays distributor commission out of the fund’s expenses, so its expense ratio is higher. SEBI has made direct plans the default on fund houses’ own digital platforms from 1 November 2026, with investors choosing regular plans being told of the higher cost.

Take a hypothetical ₹10 lakh invested for twenty years, earning 12% a year before costs. Three illustrative all-in annual costs give three very different results.

₹69.8 lakh at 10.2% net: an active fund in a regular plan costing 1.8%.

₹82.1 lakh at 11.1% net: the same fund in a direct plan costing 0.9%.

₹93.1 lakh at 11.8% net: a low-cost index fund costing 0.2%.

Moving from regular to direct is worth about ₹12.3 lakh in this example. Nobody can promise which fund will win. The cost difference, however, is guaranteed to be there.

Next Cutting costs is the easiest decision you can make about a fund. Explore Brokerage Free Investments to see how it could fit the way you invest.

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08 What the scorecards say

If past outperformance reliably continued, the long-run results of active funds would look very different from what the evidence shows. S&P Dow Jones Indices publishes the SPIVA India scorecard, which tracks how many actively managed funds beat their benchmarks, with closed and merged funds included.

3 in 4 active large-cap funds trailed their benchmark over the ten years to December 2025. For mid and small-cap funds the figure was close to four in five.

The pattern is not new. Across successive editions, over ten-year periods, more than 70% of active funds in every category have lagged their benchmarks. A fund can have a brilliant year, or even a brilliant five, and still be on the wrong side of the long-run odds.

To be fair The data has honest critics. The large-cap benchmark used includes mid-caps that large-cap funds cannot hold, which raises the bar. And in 2025, active mid and small-cap funds fell far less than their benchmark (under 1% versus about 7.9%). Single years can go either way. The persistent pattern over a decade is the point.

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09 The behaviour gap

Even when a good fund does keep performing, investors often fail to capture it. They arrive after the surge, stop after the slump, and switch the moment a newer name tops the table. A ranking by past returns is effectively a buy-high signal.

Morningstar’s annual Mind the Gap study measures this for US funds by comparing what funds returned with what their investors actually earned after timing their purchases and sales. Over the ten years to December 2025, investors earned roughly 1.2 percentage points a year less than their funds did. The study also found that the more investors traded, the less of their funds’ returns they kept.

The data is American, but the behaviour is universal. It is also the reason the discipline of a monthly SIP works: it takes the timing decision out of your hands. A SIP you stop after a fall, or a fund you switch because a rival just topped the one-year table, undoes that advantage.

Takeaway The danger is not only that past returns mislead you about the future. It is that they make you switch, and switching has a cost of its own.

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10 What past returns are good for

None of this means history is useless. It means history answers different questions than the ones we usually ask of it. Used well, a fund’s record is excellent evidence about the things below.

Risk How far did the fund fall in its worst stretch, and how long did recovery take? A past drawdown is a far better guide to future pain than a past gain is to future pleasure.

Pattern Look at rolling returns across many start dates, not a single one-, three- or five-year snapshot that happens to end on a good day.

Costs Expense ratios and plan type are observable now and repeat reliably. They are the most predictable numbers in the whole picture.

Process Does the fund stick to its mandate? Is there a clear, repeatable reason it did well, and does that reason depend on conditions that can easily change?

Fit Can you personally sit through the worst year in its record without redeeming? Your own behaviour is part of your return.

Use history to understand risk and cost. Do not use it to forecast reward.

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→ Your pre-investment checklist

Before you buy a fund because of what it has done, click each box once you can honestly say yes.

☐ I looked at rolling returns across several periods, not one snapshot.

☐ I compared it with its category peers and the right benchmark.

☐ I know its worst fall and I would hold through a repeat.

☐ I checked the expense ratio and chose the plan (direct or regular) on purpose.

☐ I can explain why it did well, and why that could continue.

☐ I am not buying it only because it topped a ranking.

☐ If this goes badly, my important goals are still safe.

You cannot control next year’s fund return. You can control what you pay to earn it.

That is the idea behind Brokerage Free Investments: keeping more of what you earn, so that more of it compounds for you. If that matches how you want to invest, take a look.

Visit Brokerage Free Investments  →

Mutual fund investments are subject to market risks. Read all scheme-related documents carefully. This document is for education only and is not investment, tax or legal advice. Figures are illustrative or drawn from published research and may be revised. Please consider speaking to a SEBI-registered adviser before investing.