DON'T BE TRAPPED: HOW MUTUAL FUND MARKETING MISGUIDES INVESTORS AND WHY LONG-TERM RETURNS MATTER!

Investors often enter the world of equity mutual funds lured by their short-term returns. But a closer look at their long-term performance reveals a consistent pattern of underperformance against benchmarks. Mutual fund underperformance isn’t limited to regular plans alone—it extends to direct plans as well. While direct funds have lower expense ratios compared to regular plans, the difference in returns is often marginal. This further raises the question: Are mutual funds, in any form, the optimal choice for long-term wealth creation?

Let’s unpack the reality, using the above data as a prime example.

The Misleading Focus on Short-Term Returns

In the 1-year performance:

Large-Cap Funds showed a return of 28.16%, marginally higher than their benchmarks BSE 100 (27.19%) and Nifty 100 (27.49%).

Mid-Cap Funds and Small-Cap Funds too posted returns higher than benchmarks, creating an illusion of superior performance.

Many investors fall prey to the lure of short-term performance metrics (1-3 years) aggressively marketed by:

1. Asset Management Companies (AMCs): By promoting schemes with recent stellar performance, they often obscure the long-term performance history and volatility

2. Banks and Mutual Fund Distributors: Frequently push high-commission products without assessing their suitability for the investor’s goals.

3. Online Platforms (e.g., Groww, Zerodha): Focus on displaying short-term returns without meaningful benchmarks, creating a false impression of consistent returns.

For instance, while a 1-year return like 36.33% in mid-cap funds appears impressive, it says little about long-term resilience or alignment with investor goals. Such selective marketing risks trapping investors into chasing returns rather than focusing on a well-thought-out strategy aligned with financial objectives.

Underperformance Over the Medium to Long Term

When we shift focus to medium- and long-term performance (5-year and 10-year returns), the cracks in the story begin to show:

Large-Cap Funds:

5-Year Return: 16.32% vs Benchmark 17.56% (BSE 100).

10-Year Return: 12.24% vs Benchmark 13.11% (BSE 100).

2. Mid-Cap Funds:

5-Year Return: 25.98% vs Benchmark 28.04%.

10-Year Return: 17.06% vs Benchmark 19.04%.

Small-Cap Funds:

5-Year Return: 30.75%, slightly beating 30.33% (benchmark). However, the 10-Year Return lags at 18.46% vs Benchmark 22.24%.

How Investors Are Trapped

Focus on Short-Term Gains: AMCs and platforms aggressively market 1- and 3-year returns, which appear lucrative. Investors are rarely informed about underperformance in longer durations or benchmark comparisons.

2. Opaque Comparisons: Fund advertisements and platforms often exclude benchmark data or present funds in isolation, misleading investors.

3. Conflict of Interest: Banks, mutual fund distributors, and online platforms earn commissions or transaction fees for fund sales. Hence, they prioritize sales over investors’ goals.

4. Illusion of Simplicity: Mutual funds are marketed as “one-size-fits-all,” akin to Dolo-650, suitable for every investor. In reality, funds must align with specific financial goals and risk tolerance.

Why the Underperformance?

High Expense Ratios: Regular funds charge management fees and commissions, eroding returns. Even direct funds often struggle due to other inefficiencies.

Market Efficiency: Benchmarks like Nifty 100 or Nifty Midcap 150 are free of management costs and reflect pure market returns. Most fund managers fail to outperform due to increased market efficiency.

Overdiversification: Mutual funds tend to diversify excessively, diluting potential returns from high-performing stocks.

Behavioral Bias: Frequent churn by fund managers to align with market sentiment impacts returns negatively.

Benchmark Constraints: Funds must adhere to specific investment mandates, limiting flexibility to outperform during volatile markets.

Why the Gap Will Widen

Index Funds and ETFs: With growing investor awareness, passive investing (index funds/ETFs) is becoming popular. These have lower costs and directly track benchmarks, leading to better net returns for investors.
Technological Disruption: Algorithm-driven investing and increased data availability will likely narrow the gap between active funds and benchmarks further, exposing fund inefficiencies.
High Competition: With more funds entering the market, achieving outperformance will only become tougher.

The Critical Role of Long-Term Returns

Consider a parent investing in an Equity Large-Cap Mutual Fund to accumulate ₹50 lakhs for their daughter’s higher education in 20 years. They trust the fund’s historical returns and assume it will grow at a rate of 12.24% p.a., the 10-year return for Large-Cap Funds (as per the above data). However, the benchmark (BSE 100) has delivered 13.11% p.a. over the same period.

This small difference may appear insignificant at first glance, but let’s calculate its impact over 20 years:

The Numbers Don’t Lie

1. If the mutual fund returns 12.24% p.a.

Investment: ₹10 lakhs
Future Value after 20 years: ₹9,80,9250 (~₹98.1 lakhs)

2. If the benchmark returns 13.11% p.a.

Investment: ₹10 lakhs
Future Value after 20 years: ₹11,68,6520 (~₹1.16 crore)

Gap in Returns: ₹1.86 lakhs!

What This Means for the Parent: Instead of comfortably funding their daughter’s higher education, they would now need to dip into personal savings, take a loan, or compromise on the quality of education. All because the fund lagged behind the benchmark.

Imagine a Worsening Scenario

If the gap between fund returns and benchmark widens over the next 20 years (as current trends suggest), the underperformance could grow exponentially. This could mean falling 10-15% short of the desired corpus, leaving the investor underprepared for one of their life’s most critical financial goals.

Emotional and Financial Stress: The inability to fund your child’s education can lead to:

Emotional distress for both the investor and the child.
Additional financial burden through loans, with interest rates eating further into savings.
The regret of trusting a mutual fund without understanding its limitations.

Key Lessons for Investors

1. Don’t Ignore Benchmarks: Always compare the fund’s long-term performance with its benchmark. If the fund consistently underperforms, consider alternative options.

2. Opt for Index Funds or ETFs: These passive investments closely mirror benchmark returns with lower expense ratios, ensuring the gap between your investments and benchmarks remains minimal.

3. Account for Real Costs: Factor in expense ratios, distributor fees, and platform charges. These may seem small but significantly impact long-term returns.

4. Align Investments with Goals: Your investment strategy must consider inflation-adjusted returns, not just absolute numbers. Equity mutual funds are not a “Dolo-650”—a one-size-fits-all solution. Different goals require different investment approaches.

Conclusion: What’s at Stake?

Underperformance is not just a matter of missing a percentage point; it can have a cascading effect on your life goals. If the gap between equity mutual funds and benchmarks continues to widen, millions of investors could find themselves underprepared for milestones like education, marriage, or retirement.

Instead of falling prey to aggressive marketing tactics by AMCs, banks, or online platforms, focus on benchmark-beating options like direct equity, index funds, or ETFs. Remember, when it comes to securing your future, staying informed is the only way to ensure you’re not left counting the cost of misplaced trust.

About Author

Vinayak Savanur

Founder & CIO at Sukhanidhi Investment Advisors, a SEBI registered equity investment advisory firm. He has nearly a decade of experience in the stock markets and has been a holistic financial planner.