If a fund performs exceptionally well with highest returns in a category, more and more money from investors flows into the fund, and then a time comes when the fund manager is not able to generate the same return as he/she was generating when the fund size was small. The fund eventually drops down from top position in the category to a lower position, based on the returns. This is called winner’s curse in mutual fund. For example – This happened with Axis small cap fund few years back, and happening with most of the Quant mutual fund schemes now.
As discussed in our previous blog, small fund size or AUM is easier to be managed. Please refer to the link below for previous blog:
The difficulty of managing higher AUM is most difficult in case of smallcap funds wherein the size of companies are small (with market cap of few thousand crores) as compared to large or mid cap funds.
Winner’s curse is something that cannot be avoided. Then, how does investor decide on sticking to a particular fund?
First of all, when an investor starts, it’s always good to start with a consistent performing fund. It is good to watch few interviews of the fund manager to understand his/her style of investing. It is recommended to be invested in a fund being managed by a fund manager having good track record of performance.
Now, suppose an Investor A has done all these and chosen a fund which is in top 25% funds of the category based on returns. The fund performs better and secures rank 1 in the category based on returns. This will draw attention of more and more investors to the fund, and the inflow to the fund will increase. It will probably increase to a limit wherein money in the fund becomes difficult to manage, and eventually fund drops from rank 1 to a lower rank based on returns. So, should investor A exit at this point?
To answer this question, there are few things investor should be checking:
- Is the fund manager same with whom investor A started?
- Is the fund consistently performing in 3, 5 and 7 years period, beating the benchmark and category average return?
If the answer to the two questions above are ‘Yes’, it is a good idea to continue with the fund. Because what would probably further happen is that when the fund drops from rank 1 to a lower rank based on returns, the high inflow would stop, and in some cases there could be outflow as well. Even if there is no outflow, but as the market size increases, it becomes again easier for the fund manager to manage the fund and generate superior returns.
The text explains the “winner’s curse” in mutual funds, where a fund’s exceptional performance attracts more investors, making it harder for the manager to sustain high returns. This often leads to a decline in the fund’s ranking over time. The example of Axis Small Cap Fund and Quant mutual funds highlights this phenomenon. It’s crucial for investors to consider the fund manager’s track record and the fund’s consistency before making decisions. Should an investor exit a fund when it drops from the top rank?
What factors should an investor prioritize when deciding whether to stay invested in a fund that has recently declined in performance?
Hello, Thanks for your comments. As per my understanding, a fund getting dropped from the top rank should not be the only criteria for exiting a fund. If a investor does that, he or she will keep on switching the funds every year and at the end will get a low or mediocre return. The investor should check if the fund has beaten the benchmark and category average in 3, 5 or 7 years period. If it has, the investor should not think of exiting the fund. Adding to that, fund managers invest in specific style of investment, which could be growth, value, mix of the two, momentum, etc. Some style of investment work in a particular duration or phase of market while other style of investment may work in some other duration or phase of the market.
This is an insightful analysis of the “winner’s curse” phenomenon in mutual funds, particularly relevant for investors navigating small-cap funds. It highlights the challenges fund managers face as AUM grows, especially in managing smaller companies. The example of Axis Small Cap Fund and Quant mutual funds provides a real-world context to the issue. It’s crucial for investors to assess a fund manager’s track record and investment style before committing. Should investors remain in a fund even after it drops from the top rank, provided the fundamentals remain strong?
Hello, Thanks for your comments. As per my understanding, a fund getting dropped from the top rank should not be the only criteria for exiting a fund. If a investor does that, he or she will keep on switching the funds every year and at the end will get a low or mediocre return. The investor should check if the fund has beaten the benchmark and category average in 3, 5 or 7 years period. If it has, the investor should not think of exiting the fund. Adding to that, fund managers invest in specific style of investment, which could be growth, value, mix of the two, momentum, etc. Some style of investment work in a particular duration or phase of market while other style of investment may work in some other duration or phase of the market. So, to answer your question on one line ‘Investor should never think of exiting a fund on the basis of drop from top rank if the fundamental remains strong’.
Hello, Thanks for your comments. You can use advisorkhoj.com, mfonline.co.in, rupeevest.com, etc. The data of all these websites are same as far as rolling returns comparison are considered.
As per my understanding, this method works well but additionally, the following factors needs to be considered before investing:
1) Track record of fund manager.
2) AUM of the fund – low to moderate in the category.
3) Expense ratio – low to moderate in the category.
4) Track record of the fund. If the fund has not been in existence for long time, investor should at least consider fund with fund manager who has performed very well in other funds he or she managed.
You can find detailed explanation of these points in other blogs on the website.