There are some who may dismiss this as a pointless question with an obvious answer. But if you are willing to read this with an open mind, it might just be worth your while. Some of the thoughts presented here have been shared in the past, across different posts. In this post, I’m attempting to connect these together to suggest an answer to the question in the title.
Do past returns really matter?
Most of us, when deciding on a scheme to invest into, look at its past returns. Whether we admit it or not, most of us believe that a scheme’s past returns (relative to its peers) are a reliable indicator of its future relative returns. In other words, we believe that if Fund A has given a better return than Fund B in the past, it is likely to give a better return in the future as well.
Frankly, I have not seen any data that would compellingly support such a view. On the contrary, based on the data that I have examined, I question such a belief. As evidence, I’ve given below some observations from a study that I recently updated. In this, I looked at the relative returns of domestic, diversified equity schemes over four market phases, listed below.
- 8 January, 2008 to 9 March, 2009 (Falling)
- 9 March, 2009 to 5 November, 2010 (Rising)
- 5 November, 2010 to 20 December, 2011 (Falling)
- 20 December, 2011 to 29 January, 2015 (Rising)
The study covered 141 schemes that had been around across all these four phases. Based on their return in each phase, I grouped these schemes into quartiles. These are a few of my findings:
- 33 of the 35 schemes in the top quartile in 2008-09 were not in the top quartile in 2009-10. Of these, 26 dropped to the third or fourth quartile.
- 29 of the 35 schemes in the top quartile in 2009-10 were not in the top quartile in 2010-11. Of these, 19 dropped to the third or fourth quartile.
- 30 of the 35 schemes in the top quartile in 2010-11 were not in the top quartile in 2011-15. Of these, 19 dropped to the third or fourth quartile.
- Not a single scheme managed to be in the top quartile across all four phases. Only 7 schemes consistently ended up in one of the top two quartiles in each of the four phases.
To me, what emerges from this is that the past ranking of a scheme is not a reliable indicator of what its future ranking will be. In case you’d like to take a look at the data supporting these findings, please send me an email.
Do future returns matter?
Once we invest in a scheme, it should be correct to believe that the scheme’s returns will impact our returns, right? Well, yes and no. If we make a single investment, then yes. If we make multiple investments, then maybe not. Let me illustrate.
Let’s say that 10 years ago, someone decided to start SIPs of an equal amount in the growth options of these schemes:
- Reliance Regular Savings Fund-Equity Option (RRSF)
- SBI Magnum Midcap Fund (SBIMMF)
Over these 10 years, RRSF ended up giving a higher return than SBIMMF. However, the investor would made more money in SBIMMF than in RRSF. The table below shows the difference.
| Period: 1 May 2006 to 30 Apr 2016 | Scheme Return (p.a.) | Investor Return (p.a.) |
|---|---|---|
| RRSF | 13.8% | 13.4% |
| SBIMMF | 11.3% | 18.0% |
Scheme returns and investor returns have been calculated using the tools at Advisorkhoj and assume a monthly SIP on the first business day of each month. Loads are not considered.
Let me try and give these numbers a bit more context. The growth in the NAV of RRSF over this period was 36% more than the growth in the NAV of SBIMMF. Yet, the gain to the investor from investing in SBIMMF was 57% more than the gain from investing in RRSF. I look at this as proof that investing in a scheme that gives better returns, in no way, guarantees that we will get better returns. Indeed, the returns to us can be far less than what we may imagine.
The role of returns in building wealth
I remember a thought shared by a stock broker in my early days in the business. I paraphrase: “You may earn a 100% in a year but if all you invested is Rs.100, all you will have at the end of the year is Rs.200. By no stretch of imagination will you be wealthy just by seeking high returns.”
I have regarded that as a useful comment on how wealth is built. To refine it a bit, the wealth that we build is most influenced by the amount that we save and invest, and the timeliness of our investments (i.e. our ability to invest regularly, without delay). We can, and must supplement these with good investment choices. However, we need to realize that there are practical limits to the rate of return that we can earn from our investments on a sustained basis. And if the points made earlier are anything to go by, we have limited control over the return that we will end up getting.
Putting all of this together, I would like to suggest that a scheme’s returns are not as consequential as most of us might believe. But I’ll let you be the final judge of that. And along with what I have, so far, shared in this post, I’d like to offer you a parting thought that puts a whole different spin on the question in the title.
Most good things in life come at a price. Generally speaking, the more important something is to us, the higher is the price that we are willing to pay. Conversely, the higher the price that we are willing to pay for something, the more important it can be considered to be to us. Thus, the importance of a scheme’s returns to us can well be judged by the price we would be willing to pay or, more accurately, the compromises that we are willing (or not willing) to make. Let me explain with a personal example.
I have taken a stance to not invest my money with HDFC mutual fund. To be clear, I have great respect for their Chief Investment Officer as an equity fund manager. I have no reason to doubt his ability to generate better returns than most of his peers. On the flip side, I have regarded their disclosures around expense ratios as inconsistent and opaque. Nonetheless, a few years ago, I went ahead and invested a small portion of my portfolio with them. I was clear that I was making a compromise. But then, a series of service issues started popping up which left an extremely bitter taste in my mouth. To put it bluntly, I felt like I was being yanked around. After a bit of deliberation, I came to the conclusion that this fund house did not deserve my business, and pulled out my investments. In other words, this time around, I refused to compromise.
Yes, I am a small investor, and my stance may not affect them. Some of my well-wishers have argued that I have had more to lose than them by depriving myself of good returns. Fact is, that doesn’t bother me. For my part, I am clear on where I draw the line on making a compromise, and my actions reflect that. And that’s really the question we have to ask ourselves. Would you be willing to chase the promise of ‘good returns’ at any cost? Or would you want to draw the line somewhere? And, if so, where would you draw it?
