New approaches to mutual fund comparison unveil hidden risks and performance pitfalls

Analysing mutual fund returns with renewed scrutiny, financial experts reveal that simplistic comparisons can mislead investors. Emphasising category-matching, benchmark relevance, cost structures, and portfolio risks offers a more comprehensive view of fund performance and resilience.

Judging a mutual fund by its latest one-year or three-year return is not just simplistic; it can be misleading if the schemes being compared were never comparable in the first place. The Association of Mutual Funds in India says investors should match funds within the same category, with the same investment objective, broadly similar asset allocation and the same benchmark, and should compare them over the same period. Its own beginner’s example is blunt: putting a bluechip fund next to a small-cap fund because both sit in the equity bucket is like comparing an SUV with a saloon. (mutualfundssahihai.com)

Once that like-for-like test is passed, the return figure should be treated as a starting point rather than a verdict. AMFI’s investor material distinguishes between trailing returns, which are a “point-to-point” reading between two dates, and rolling returns, which examine overlapping periods and can be calculated daily, weekly or monthly to show how consistently a scheme has behaved. That matters because a single five-year number can flatter a fund that happened to hit one favourable window, while rolling data are better at exposing whether performance held up through changing market conditions. AMFI also notes that returns become far more meaningful when they are read against the fund’s own benchmark, because that reveals genuine outperformance or underperformance rather than simple peer-group ranking. (mutualfundssahihai.com)

The benchmark itself also needs scrutiny. AMFI says the more appropriate yardstick for equity mutual funds is the Total Return Index, or TRI, because it includes dividends, bond interest and other income from index constituents, and assumes that income is reinvested. That is a stricter test than the older price-only index method, which captured capital appreciation but ignored cash distributions. SEBI formally pushed the industry in that direction in 2018, and the regulator’s circular on 22 October that year set the framework for total expense ratio and performance disclosure. In practical terms, that means an apparent beat against an older-style benchmark may say more about the benchmark’s design than the manager’s skill. (mutualfundssahihai.com)

Costs deserve the same level of attention as performance tables. AMFI’s educational guidance says a lower expense ratio is better for investors, while Vanguard argues that “the higher the costs, the higher the hurdle” for a manager trying to beat a benchmark after fees. That is only part of the bill. Vanguard says turnover, or how much a manager trades, brings extra friction through commissions and market impact, both of which eat into returns even though they sit outside the headline fee. SEBI’s October 2018 circular matters here because it underpins the standardised TER disclosure regime that allows investors to compare schemes on a like-for-like basis rather than taking marketing material at face value. (mutualfundssahihai.com)

What sits inside the portfolio can explain far more than a return chart ever will. AMFI advises investors to inspect the top 10 sector and stock exposures to see whether a fund is genuinely diversified or simply looks diversified by holding many names while still leaning heavily on a few sectors. The trade-off is straightforward: concentration can boost gains when a manager’s convictions are right, but it can also magnify damage when those calls go wrong. Risk measures help decode that behaviour. AMFI says standard deviation gives a sense of how widely returns fluctuate around their average, while beta shows sensitivity to the market; a beta above 1 means the fund is likely to move more sharply than the market in both rallies and sell-offs, while lower-risk equity funds usually sit below 1. (mutualfundssahihai.com)

Size and performance in falling markets also warrant a closer look. Vanguard’s research, based on 1,600 actively managed US equity funds and monthly data from January 1990 to December 2022, found that fund size, turnover, cost and capture ratio all had a statistically significant relationship with later excess returns. But it also warned that very large funds can struggle when their opportunity set is less liquid, because taking meaningful positions becomes harder and trading costs can rise. Its description of capture ratio is useful for investors trying to look past headline gains: a fund with 120% upside capture but 130% downside capture may look good in a long bull market, yet still be poorly built for a full cycle because it gives back too much when conditions worsen. (workplace.vanguard.com)

People and process are the final check on any glossy track record. AMFI says fund selection has two stages: first deciding on an investor’s own goal, time horizon and tolerance for risk, then screening the shortlist using portfolio details, vintage, manager history, expenses and benchmark-relative performance. Vintage matters because it shows how many economic cycles a scheme has actually lived through, while a manager’s other funds can offer clues about whether results are repeatable or luck-driven. Vanguard adds a useful note of caution: its four quantitative characteristics explained less than 20% of future relative performance variability, leaving more than 80% unexplained. In other words, firm quality, investment philosophy, research depth and team cohesion still matter, even after the spreadsheet work is done. (mutualfundssahihai.com)

The practical lesson is not to ignore returns, but to demote them from headline attraction to first filter. A credible fund comparison starts with category, objective, asset mix and benchmark, then moves through TRI-based benchmark testing, costs, turnover, concentration, volatility, beta, capture ratios, vintage and manager continuity. That is more effort than scrolling to the biggest recent number on an app, but it is also a better way to work out whether two funds that look similar on paper are actually taking the same risks, charging the same price and offering the same odds of holding up when markets turn. (mutualfundssahihai.com)