{"id":30802,"date":"2024-11-12T15:47:53","date_gmt":"2024-11-12T10:17:53","guid":{"rendered":"https:\/\/www.fundsindia.com\/blog\/?p=30802"},"modified":"2024-11-12T15:47:54","modified_gmt":"2024-11-12T10:17:54","slug":"winning-funds-losing-streaks-decoding-the-mystery-of-short-term-underperformance","status":"publish","type":"post","link":"https:\/\/www.fundsindia.com\/blog\/mf-research\/winning-funds-losing-streaks-decoding-the-mystery-of-short-term-underperformance\/30802","title":{"rendered":"Winning Funds, Losing Streaks: Decoding the Mystery of Short-Term Underperformance"},"content":{"rendered":"\n<figure class=\"wp-block-image size-large\"><a href=\"https:\/\/www.fundsindia.com\/blog\/wp-content\/uploads\/2024\/11\/RC-Blog-Banner-November.jpg\"><img loading=\"lazy\" width=\"1024\" height=\"512\" src=\"https:\/\/www.fundsindia.com\/blog\/wp-content\/uploads\/2024\/11\/RC-Blog-Banner-November-1024x512.jpg\" alt=\"\" class=\"wp-image-30804\" srcset=\"https:\/\/www.fundsindia.com\/blog\/wp-content\/uploads\/2024\/11\/RC-Blog-Banner-November-1024x512.jpg 1024w, https:\/\/www.fundsindia.com\/blog\/wp-content\/uploads\/2024\/11\/RC-Blog-Banner-November-300x150.jpg 300w, https:\/\/www.fundsindia.com\/blog\/wp-content\/uploads\/2024\/11\/RC-Blog-Banner-November-768x384.jpg 768w, https:\/\/www.fundsindia.com\/blog\/wp-content\/uploads\/2024\/11\/RC-Blog-Banner-November-1536x768.jpg 1536w, https:\/\/www.fundsindia.com\/blog\/wp-content\/uploads\/2024\/11\/RC-Blog-Banner-November-2048x1024.jpg 2048w\" sizes=\"(max-width: 1024px) 100vw, 1024px\" \/><\/a><\/figure>\n\n\n\n<p>History shows that investing in well-managed, diversified equity funds has led to good return outcomes over the long run.<\/p>\n\n\n\n<p>Yet, very few investors actually stick to these funds for the long term.&nbsp;<\/p>\n\n\n\n<p>Why?<\/p>\n\n\n\n<p>Let\u2019s find out\u2026<\/p>\n\n\n\n<div style=\"height:6px\" aria-hidden=\"true\" class=\"wp-block-spacer\"><\/div>\n\n\n\n<h4><strong><span style=\"color:#1c4587\" class=\"has-inline-color\">There is no escaping underperformance! (even for the best funds)<\/span><\/strong><\/h4>\n\n\n\n<p>We analyzed the performance of<strong> actively managed diversified equity fund<\/strong>s with a<strong> 10-year history<\/strong> that have <strong>outperformed<\/strong> the <strong>broader market (Nifty 500 TRI)<\/strong> by <strong>more than 1%.<\/strong><\/p>\n\n\n\n<p>From 184 available funds, we identified 29 that meet these criteria.&nbsp;<\/p>\n\n\n\n<p><strong>On average, these funds have outperformed by 116% in total, with the highest being 400% and the lowest 40%.<\/strong><\/p>\n\n\n\n<p>While these funds perform well over the long term, how do they hold up in the short term?<\/p>\n\n\n\n<p>For these funds, we looked at their performance over rolling 1-year, 3-year, and 5-year periods. The table below summarizes our findings.<\/p>\n\n\n\n<div class=\"wp-block-image\"><figure class=\"aligncenter size-large\"><a href=\"https:\/\/www.fundsindia.com\/blog\/wp-content\/uploads\/2024\/11\/Image-1.jpg\"><img loading=\"lazy\" width=\"632\" height=\"377\" src=\"https:\/\/www.fundsindia.com\/blog\/wp-content\/uploads\/2024\/11\/Image-1.jpg\" alt=\"\" class=\"wp-image-30806\" srcset=\"https:\/\/www.fundsindia.com\/blog\/wp-content\/uploads\/2024\/11\/Image-1.jpg 632w, https:\/\/www.fundsindia.com\/blog\/wp-content\/uploads\/2024\/11\/Image-1-300x179.jpg 300w\" sizes=\"(max-width: 632px) 100vw, 632px\" \/><\/a><\/figure><\/div>\n\n\n\n<p>Here comes the surprise\u2026<\/p>\n\n\n\n<ul><li>Over a 1-year period, these<strong> funds<\/strong> (which outperformed over 10 years) have <strong>underperformed<\/strong> about <strong>40% of the time<\/strong>, with an <strong>average underperformance<\/strong> of <strong>4.4%.&nbsp;<\/strong><\/li><\/ul>\n\n\n\n<ul><li>Even over a <strong>3 to 5-year period<\/strong>, which is often perceived as \u2018long term\u2019, these funds <strong>underperformed 1\/3rd of the time<\/strong>, with an <strong>average underperformance<\/strong> of <strong>1% to 2%.<\/strong><\/li><\/ul>\n\n\n\n<p>Let\u2019s extend this analysis further and take a look at diversified equity funds with a 15-year history.<\/p>\n\n\n\n<div class=\"wp-block-image\"><figure class=\"aligncenter size-large\"><a href=\"https:\/\/www.fundsindia.com\/blog\/wp-content\/uploads\/2024\/11\/Image-2.jpg\"><img loading=\"lazy\" width=\"641\" height=\"381\" src=\"https:\/\/www.fundsindia.com\/blog\/wp-content\/uploads\/2024\/11\/Image-2.jpg\" alt=\"\" class=\"wp-image-30807\" srcset=\"https:\/\/www.fundsindia.com\/blog\/wp-content\/uploads\/2024\/11\/Image-2.jpg 641w, https:\/\/www.fundsindia.com\/blog\/wp-content\/uploads\/2024\/11\/Image-2-300x178.jpg 300w\" sizes=\"(max-width: 641px) 100vw, 641px\" \/><\/a><\/figure><\/div>\n\n\n\n<p>From 184 available funds, we identified 39 funds that have outperformed the Nifty 500 TRI by more than 1% per year for the last 15 years.&nbsp;<\/p>\n\n\n\n<p>On average, these funds have outperformed Nifty 500 TRI by 290% over the last 15 years, with the highest being 866% and the lowest 102%.<\/p>\n\n\n\n<p>However,<\/p>\n\n\n\n<ul><li>Over a 1-year period, these<strong> funds<\/strong> (which outperformed over 15 years) have <strong>underperformed<\/strong> about <strong>39% of the time<\/strong>, with an <strong>average underperformance<\/strong> of <strong>4.7%.&nbsp;<\/strong><\/li><\/ul>\n\n\n\n<ul><li>Even over a <strong>3 to 5-year period<\/strong>, which is often perceived as \u2018long term\u2019, these funds <strong>underperformed ~1\/3rd of the time<\/strong>, with an <strong>average underperformance<\/strong> of <strong>1.5% to 3%.<\/strong><\/li><\/ul>\n\n\n\n<div style=\"height:11px\" aria-hidden=\"true\" class=\"wp-block-spacer\"><\/div>\n\n\n\n<p style=\"font-size:17px\"><strong>Then how do these funds still end up doing well over the long run?<\/strong><\/p>\n\n\n\n<p>In most cases, for well managed diversified equity funds, underperformance is almost a given. However, the underperformance phase is temporary and is usually followed by a phase of sharp outperformance that adequately overcompensates for the underperformance. This is how good equity funds end up outperforming over the long term.&nbsp;<\/p>\n\n\n\n<h4><strong><span style=\"color:#38761d\" class=\"has-inline-color\">Insight 1: \u2018Accept\u2019 and \u2018Expect\u2019 all good, actively managed, diversified equity funds to go through temporary periods of short-term underperformance.&nbsp;<\/span><\/strong><\/h4>\n\n\n\n<h4><strong><span style=\"color:#1c4587\" class=\"has-inline-color\">Weird Challenge for Long Term Equity Fund Investors<\/span><br><\/strong><\/h4>\n\n\n\n<p>This creates a weird challenge for long-term equity fund investors.<\/p>\n\n\n\n<p>Going by the above logic, you should stay invested in a fund, accepting that temporary underperformance is common and that it may still do well in the long run.<\/p>\n\n\n\n<p>But, simply assuming all underperforming funds will bounce back can lead to complacency, and you may end up holding weaker funds that continue to underperform over time.<\/p>\n\n\n\n<p><strong>So, how do you differentiate between a good fund experiencing a temporary underperformance vs a weaker one facing a more serious, long-term underperformance?<\/strong><\/p>\n\n\n\n<h4><strong><span style=\"color:#1c4587\" class=\"has-inline-color\">Differentiating good and bad underperformance<\/span><\/strong><\/h4>\n\n\n\n<p>Here is a simple checklist that you can use to differentiate between a good fund going through temporary underperformance and a bad fund going through sustained underperformance.&nbsp;<\/p>\n\n\n\n<div style=\"height:21px\" aria-hidden=\"true\" class=\"wp-block-spacer\"><\/div>\n\n\n\n<ol><li><em>Is there historical evidence that the fund consistently outperforms over long periods of time? (check rolling returns over 5Y, 7Y &amp; 10Y)<\/em><\/li><li><em>Has the fund managed risk well? (check for extent of temporary declines vs benchmark, portfolio concentration, presence of low quality stocks etc)<\/em><\/li><li><em>Does the fund manager have a long-term track record?<\/em><\/li><li><em>What is the investment philosophy and has it remained consistent across market cycles?<\/em><\/li><li><em>Is the fund portfolio available at reasonable valuations?<\/em><\/li><li><em>Does the fund face size constraints with respect to the strategy?<\/em><\/li><li><em>What is the current portfolio positioning?<\/em><\/li><li><em>Is the fund sticking to its original style and strategy despite underperformance?<\/em><\/li><li><em>Does the fund communicate transparently and regularly?&nbsp;<\/em><\/li><\/ol>\n\n\n\n<p><strong>If any fund fares well in all the above parameters and is going through near-term underperformance, then this fund might be a good mean reversion candidate with a strong potential for higher returns in the coming years.<\/strong><br><br>We have successfully applied this framework to identify funds such as IDFC Sterling Value Fund (Feb-2020), HDFC Flexi Cap Fund (Aug-2021), Franklin Prima Fund (Aug-2022), UTI Flexi cap fund (Apr-2024) etc before their turnaround. If interested, you can read about how we applied the framework <a href=\"https:\/\/fundsindia.com\/blog\/mf-research\/idfc-sterling-value-fund\/17796\">here<\/a> and <a href=\"https:\/\/www.fundsindia.com\/blog\/mf-research\/is-it-possible-to-distinguish-good-underperformance-from-bad-underperformance-in-equity-funds\/24704\">here.<\/a><\/p>\n\n\n\n<h4><strong><span style=\"color:#38761d\" class=\"has-inline-color\">Insight 2: Don\u2019t exit funds ONLY based on short-term underperformance &#8211; differentiate \u2018good\u2019 vs \u2018bad\u2019 underperformance<\/span><\/strong><\/h4>\n\n\n\n<h4><strong><span style=\"color:#1c4587\" class=\"has-inline-color\">Reducing the mental discomfort of sticking with underperforming investments<\/span><\/strong><\/h4>\n\n\n\n<p>If all the funds in your portfolio follow the <strong>same investment style\/approach<\/strong>, there might be times when <strong>all of them underperform at once<\/strong>, causing the <strong>whole portfolio to do poorly<\/strong>. This can be tough to deal with psychologically.<\/p>\n\n\n\n<p>From a behavioral standpoint,<strong> diversifying your portfolio with different investment styles\/approaches can help you stick with temporarily underperforming funds<\/strong>. When you have other funds with different investment styles that are doing well, the overall returns of your portfolio can still be acceptable, making it easier to tolerate the underperformance of some funds.<\/p>\n\n\n\n<p>At FundsIndia we use a portfolio construction strategy called the <strong>5 Finger Framework<\/strong> where the investments are made equally into funds that follow five different investment styles \u2013 <strong>Quality, Value, Blend, Mid\/Small and Momentum.&nbsp;<\/strong><\/p>\n\n\n\n<h4><strong><span style=\"color:#38761d\" class=\"has-inline-color\">Insight 3: Diversify across different investment approaches<\/span><\/strong><\/h4>\n\n\n\n<h3><strong><span style=\"color:#bf9000\" class=\"has-inline-color\">What should you do?<\/span><\/strong><\/h3>\n\n\n\n<ul><li>While good equity funds do well over the long run, the <strong>real challenge<\/strong> is to to <strong>stick to such funds<\/strong> through their <strong>inevitable but temporary underperformance phase<\/strong> which can sometimes extend for several years<br><\/li><li><strong>How to handle equity fund underperformance?<\/strong><strong><br><\/strong><\/li><\/ul>\n\n\n\n<ol><li><strong>\u2018Accept\u2019 <\/strong>and \u2018<strong>Expect\u2019 <\/strong>all your <strong>actively managed equity funds<\/strong> to <strong>underperform<\/strong> at <strong>some point in time<\/strong> in the<strong> future<\/strong><\/li><\/ol>\n\n\n\n<ol start=\"2\"><li><strong>Don\u2019t exit funds <\/strong><strong><em>only<\/em><\/strong><strong> <\/strong>based on<strong> short-term underperformance <\/strong>&#8211; <strong>differentiate \u2018good\u2019 <\/strong>vs<strong> \u2018bad\u2019 underperformance<\/strong><\/li><\/ol>\n\n\n\n<ol start=\"3\"><li><strong>Diversify <\/strong>across<strong> Different Investment Styles\/Approaches<\/strong><\/li><\/ol>\n","protected":false},"excerpt":{"rendered":"<p>History shows that investing in well-managed, diversified equity funds has led to good return outcomes over the long run. Yet, very few investors actually stick to these funds for the long term.&nbsp; Why? Let\u2019s find out\u2026 There is no escaping underperformance! (even for the best funds) We analyzed the performance of actively managed diversified equity [&hellip;]<\/p>\n","protected":false},"author":49,"featured_media":30804,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[508,506,509,376],"tags":[758,486,494,243,201,361,148,914,403,903,681,705,886],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v17.3 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>Winning Funds, Losing Streaks: Decoding the Mystery of Short-Term Underperformance<\/title>\n<meta name=\"description\" content=\"Very few investors actually hold on to well-managed equity funds for the long term. 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