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Quibbling Over Returns

A hair-splitting exercise over past performances of funds will not point to their future performances

In using numbers of any kind, it’s good to be as precise as needed but no more. Let me explain. If you informed someone that Delhi was 1,400 kms from Mumbai and were told in reply that was wrong and that Mumbai was actually 1,407 kms away, is the answer more accurate? Perhaps. More useful? I’m not so sure. Would you pay more for a thermometer that told you that your fever was 102.486 instead of 102.5? You wouldn’t.

However, I constantly find that investors making the same sort of quibbles about the returns that mutual funds have generated. As of today, the one-year returns of the top-performing diversified equity mutual funds are 67.05 per cent and those of the second-best category are 64.77 per cent. There’s no shortage of investors who consider this difference to be relevant and would actually base their investment decisions on it. In reality, such a difference is irrelevant.

It’s true that, while I’m complaining about this over-precision, you could lay part of the blame at my doorstep. After all, it’s ValueResearchOnline.com and other websites like it that are the prime publicisers of comparative returns calculated with great precision for every fund that exists. When you come to ValueResearchOnline.com, you’ll not only find every fund’s returns calculated to two places of decimal, but also funds ranked according to these returns. However, the question is not the availability of the returns data, but the use that it’s put to.

Past performance is important and is realistically one of the few pieces of hard information you have on which to base your decisions, but it’s important only in broad swathes and then only when seen in conjunction with many different time periods. Returns of a fund need to be seen in relation to the entire range of returns that funds of a type have. Here’s an example. Currently, there are 215 diversified equity funds that have been around for six months or more. Of these, almost a hundred have six-month returns of about 75 per cent or more. The actual range goes up to 119 per cent. However, I would say that there’s no real difference between this group of funds.

Don’t get me wrong. I’m not saying that the difference between 75 per cent and 119 per cent is irrelevant. Had you invested in the top fund six months ago you would have made a lot more money than had you invested in the 100th fund. What I’m saying is that this difference is irrelevant in terms of evaluating the future potential of these funds. Very broadly, there are good funds and there are average funds and there are bad funds. Differences within these groups are 20:20 hindsight. They have little relevance in terms of indicating what the future will bring.

To get a better quality of evaluation, one has to dig a little deeper. How much did a fund fall in a bad market compared to other similar funds? How much of this did it recover? How did it do compared to various benchmarks? However, as with returns, all these questions have numeric answers. The numbers that you will find online will be precise about the past, but their applicability to the future is only approximate and one must take them only as an approximate guide.