Principal Emerging Bluechip has been the best performing diversified equity mutual fund scheme over the last one year, giving a whopping return of 157.4% (as on January 29, 2010).
Should you invest in this scheme on the basis of this information? Or is this brilliant performance just a one-year wonder?
The evidence is stark. Very few top performers in one year ever manage an encore the next year. Of the 10 schemes that were on top of the list in 2009, only one made it to the top 10 list of 2010. If one looks at data before that, it doesn’t get any better. Of the top 10 schemes of 2008, none of the schemes made it to the top 10 list in 2009.
This phenomenon has been observed over the last five years. In fact, 2004 was the only exception to this rule, when six schemes that made it to the top 10 list in 2003 were also present in the top 10 in 2004 (see ‘One-year wonders’).
The main reason for this is that most schemes that make it to the top 10 in any year are small. A small scheme needs fewer stocks to do well. This performance attracts more money into the scheme and, as the assets under management go up, fund managers are left with fewer options to invest in. Also, as a mutual fund scheme becomes successful, fees it earns become more lucrative.
Jason Zweig, a respected personal finance writer, in his commentary to Benjamin Graham’s all-time investment classic.
The Intelligent Investor, wrote: “As a fund grows, its fees become more lucrative, making its managers reluctant to rock the boat. The very risk that managers took to generate their initial high returns could now drive the investors away and jeopardise all that fee income. So the biggest funds resemble a herd of identical and overfed sheep, all moving in sluggish lockstep, all saying ‘Baaaa’ at the same time.”
This is why schemes which appear in the top 10 list one year are seldom seen there in the next.
Given this, investors are well advised not to chase overt performance. An easy way for an investor to get around this problem is to invest in an index fund.
An index fund is a mutual fund that collects money from investors and invests in stocks that make up a stock market index in the same proportion as their proportion in the index. In India, index funds are available on the two major stock market indices — Sensex and Nifty. By investing in an index fund, investors can be rest assured that they will at least do as well as the market.
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