1-year return trap: Study reveals pitfalls of chasing hot mutual funds

Investors should be cautious about chasing mutual funds with recent stellar returns, a new study by HDFC Tru, the investment advisory arm of HDFC Securities, suggests.

The analysis, which spans mutual fund data from 2005 to 2025, found that one-year performance often inflates a fund’s longer-term record but is not a reliable predictor of future success.

HDFC Tru’s research shows that funds topping the charts in a given year do not consistently outperform peers in subsequent periods. The study showed that investing annually in the top-ranked large-cap mutual fund over the past 20 years delivered a compound annual growth rate (CAGR) of 14%, while consistently investing in the sixth-ranked fund generated a higher 16% CAGR. Similar patterns were observed in multi-cap, flexi-cap, and midcap strategies.

The 1-year return trap
“Recent outperformance folds into periodic returns, but higher past returns do not imply consistent future performance,” HDFC Tru said, highlighting the “1-year return trap” that can mislead investors. The advisory firm emphasised that true investment strength stems from consistent long-term performance rather than short-term spikes.

The study also tested a three-year holding period for top-ranked funds and found that annual selection based on last year’s best performers produced lower XIRR compared to investing in slightly lower-ranked funds, reinforcing the randomness of short-term returns.

HDFC Tru said investors should resist the urge to chase last year’s top funds and instead focus on consistency and long-term investment discipline.

The advisory firm noted that its findings, while drawn from mutual funds, are equally relevant for other asset managers. The report was prepared for educational purposes and does not constitute investment advice.

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