The law of averages and Top Performing Mutual Funds

Last week I wrote about how settling for average returns means beating 90% of professional MF fund managers. Today I show you why I said 90%.

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Past performance is subject to the law of averages or mean reversion. Based on past performance, the best-performing mutual fund has only a 30% chance of remaining a top-performing fund over the next three years. It means only a 9% chance of it remaining a top-performing fund over six years. In other words, 90% chance of it NOT being figured among the top quartile in terms of fund performance.

Is there a consistency in returns for the best-performing mutual funds? Let us see the data on this. The graph above shows the performance of top Indian funds across three different periods. About 35% of them stay in the top quartile from the first time segment to the next. This simply means, that of the 22 funds that are in the top quartile, only a couple of funds will remain in the top quartile over the next two cycles.

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So next time you pick a MF solely on the basis of past performance keep this graphic in mind. And give the humble low-cost Index fund a closer look.

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Have a good weekend. Stay safe.

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Regards,

Anish