How You Missed Your Mutual Fund’s Best Returns

However, very few investors have invested initially, and have held the units for three decades. India’s mutual fund industry has flourished only in recent years. So, the return of the average UTI Mastershare investor is probably different from this figure. In this scheme some investors also enter and exit at different times. In fact, investors usually enter mutual funds when past returns look good and exit when things go south.

Actual investor returns may differ from mutual fund returns due to such investor behavior. Research firm Morningstar India analyzed monthly inflow data into and out of mutual funds to calculate this gap, and published its findings in a report titled ‘Mind the Gap – India’.

Why is there a gap?

According to Morningstar, the gap can be understood with a simple example. Suppose an investor puts 1,000 in a mutual fund at the beginning of each year. That fund earns a total return of 10% in the first year, 10% in the second year and negative 10% in the third year. The return of the fund is 2.9% CAGR. But the investor’s return is actually a negative 0.4%, because less money was invested in the fund during the first two years of positive returns and more money was exposed to losses during the third year.

This example takes the case of a relatively disciplined investor who puts in the same amount every year. In fact, the inflows tend to pick up after the fund’s good returns and slow down when the returns are low. Therefore, the difference between fund and investor returns works out to be a substantial amount.

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As per the study, the overall return on equity funds in the last five years was 10% CAGR (as on 30 June 2022) but the investor return was 7.2%. Morningstar used its estimates of net investor inflows across fund categories to see how investor behavior affected their returns.

Total fund returns in debt stood at 6.2 per cent and investor returns at 4.6 per cent. The overall fund return in the case of hybrid funds was 9.2%, while the investor return was 6.2%. There are equal intervals for periods of three and ten years.

big gap

In general, the more volatile the asset class, the larger the difference. For example, the difference between fund and investor returns for flexicap funds is 3 percentage points over the past five-year period, while it is 21.8 percentage points for technology sector funds. This means that a lot of money in such funds came after the deposit and not before.

“Most investors inflow into technology sector funds when these funds saw run-ups in 2020 and 2021. Hence, most of the money is now sitting on negative returns,” explains Kaustubh Belapurkar, Director, Fund Research, Morningstar. investment advisor india

Another case is the international fund category, where the difference between fund and investor returns over the past five-year period is 7.2 percentage points. “When the US did better, the money was gone and now India is doing relatively better,” says Belapurkar.

The gap between investor and fund returns in healthcare sector funds is 3.6 percentage points, slightly higher than small cap funds, where the difference is 3.2 percentage points.

gold investment

On gold investing, the study produced some interesting findings.

While investor returns were lower than fund returns over the three- and five-year periods, 7 percentage points and 5 percentage points, respectively, investor returns were 1.7 percentage points higher over the ten-year period.

Hence, over the long term, investors who were able to time their gold investments had favorable results. But the study says that it would have been extremely difficult for investors to find the right timing.

lessons for investors

Investors often want to chase returns, and opt for funds that are outperforming in their respective fund category, or sector and theme funds that have seen a sharp run-up.

As the study shows, frequent switching from underperforming funds to outperforming funds can significantly reduce returns for investors. Investors can enter a fund after the fund’s portfolio companies have reached their peak valuation, and exit an underperforming fund when the valuation of its portfolio companies has become attractive.

The lesson from this study is to stay invested over the long term and build a well-diversified portfolio, as different asset classes and different investment styles perform well at different times. Even within the same fund category, investors can find funds with different investment styles.

If an investor really wants to allocate to a sector or thematic fund, he can do so by using Systematic Investment Plans (SIPs). SIP removes the time factor from investing, as the investment is made on a pre-determined date every month.

When the market is down, SIPs buy more units at lower prices, and when the market is up, SIPs buy fewer units at higher prices. In the long run, this will average out your purchase costs, minimizing the impact of short-term market volatility on your investments.

On average, mutual fund investors are bad market timers – investing and withdrawing money at the wrong times. Investors can avoid these behavioral biases by linking investments to financial goals, withdraw only when the target is near, and use SIPs to invest in a disciplined manner.

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