I came across this fascinating study carried on Indian MF schemes between 2000 to 2017. It is a numerical & historical explanation of what we call – Hindsight Investing. Let’s meet the ghost…
Isn’t it paradoxical that you invest for 5 years plus but look for 1 year best returns fund!
We are well aware of the disclaimer “past performance is no guarantee of future results”. Despite this, the most common method of investing in mutual funds remains by looking at past performance.
This is Hindsight investing. One thinks what is good now will remain so in the future. But one forgets that the valuation changes every minute. There are innumerable factors – know & unknown that change. So when there is a race of profit, the new idols will emerge. The old one can fall back – permanently or temporarily.
Why Investors do Hindsight Investing?
There are few reasons:
- It is easy to assume that something that was a good investment in the recent past is still a good investment.
- Past good performance will not wind up overnight. Even if it turns out bad, the momentum will at least give average returns.
- Easy to recognize as media keeps talking & gives confidence.
- Advisor finds it easy to explain. Brokers find it as an easy sale.
However, it’s not that simple.
The below study shows that there is a limited probability of getting investment decisions right which is solely based on historical data.
The below table comprises of last 17 years of data.
Funds were ranked based solely on performance for pre-defined time buckets. As you can see, in the 1-year bucket 36% of the funds continued to be top performers and 64% could not retain their position.
Similarly, in the 3-year bucket, 68% of the funds could not retain their position.
The top 25% of the funds on basis of performance are assigned Q1, the next 25% are assigned Q2, and so on.
If we translate the above numbers in terms of probability, the chance of selecting a top-performing fund basis past performance is lesser than winning a coin toss!
This was last 2000 to 2017…
What if we take the winners of 2020-21 and do hindsight. Here is the data…. Most winners had a bad past!
Just like we don’t drive a car looking at the rearview mirror, investment decisions too should not be based on mere past performance. In fact, to our mind, one needs to go beyond the norm of return-based analysis to arrive at investment decisions.
As the age-old adage goes “bet on the jockey, not the horse”, the same holds for investment wherein you lay your bet on the manager and not the fund. So how does one go about it?
In the next article, I will explain to you the styles of fund managers in the Indian MF industry.
Do let me know your queries in the comments section below.
So true. In inital years of investment journey, I used to take 1-3-5 years top performer or atleast should be in top 3-5 in the pursuit of returns generated in the past to be repeated on future, thinking it will be just a straight line.
But not sure if we do reverse way like worst performers also and correlate and see if once worst performers are later best performing and vice versa.
But I think Mutual funds should not be thought of on basis of performance alone but what risk we are able to bear or what risk the fund is taking to achieve the same return, i.e Sharpe ratio. And ultimately is the fund meeting or exceeding it’s objectives mentioned in the fund documents. Apart from that if the benchmark and the category average which it compares.
Above all investments should be based on one’s goals and definitely need a sound advisor and financial planner to guide and handhold the investors.
Unfortunately advisor or planner is seen as an overhead and people aren’t ready to understand the value of an advisor as Money is something no one wants to share or trust and as a professional is be paid fees is not recognised well atleast in Indian investor community, may be time will decide the importance of a planner. Till then self medication, I mean self (mis) management 🤣 continues.