Choosing equity mutual funds: Why long-term returns matter, but 1-year performance also deserves a look; experts explain

Investing in diversified active equity mutual funds, such as small-cap, mid-cap, large-cap, flexi-cap, and multi-cap funds, generally requires a long-term perspective because stock markets are volatile in the short term.

But what if a fund has positive three- and five-year returns but lags over one year? Experts say this warrants closer scrutiny. Here’s what investors should assess before investing, reviewing their holdings or exiting.

Why look at 1-year returns of equity funds even if 3- and 5-year returns are positive?

Gaurav Garg, Head – Research, Lemonn said the 3- and 5-year returns are averages, and averages can hide a bad recent year behind one or two exceptional ones. He cited two examples.

• Motilal Oswal Midcap Fund delivered a 3-year return of 18.27% as of 10 September 2026, well ahead of its benchmark’s 15.22%. But its 1-year return was 0.28%, against 4.92% for the benchmark.
• HDFC Small Cap’s 5-year return is still about 14% a year. Its 1-year return was negative as of 30 September 2026, while the category average was close to 10%.

Vedant Gupte, Co-Founder and CEO of Investment platform Trackk, said a weak one-year return in a falling market that still beats peers is a good sign. But one-year returns also help distinguish funds that consistently outperform peers from those whose long-term track records depend on one or two exceptional years.

“Long-term returns tell you whether a fund has been good; the one-year tells you whether it still is. Investors need both, and most only check the first,” he added.

Harsh Vardhan Dawar, ACA, CFA, FRM, Founder of Wealth Cafe, said long-term rolling returns should carry greater weight than short-term returns when evaluating an equity fund. However, investors must analyse the reasons behind any short-term underperformance.

What key indicators should investors look at?

Garg explained the following metrics investors should assess to analyse the performance of equity funds.

Dawar mentioned a key point. Compare a fund’s performance with its relevant benchmark. For instance, investors should assess a large-cap fund against a large-cap index rather than compare its returns with those of small- or mid-cap funds.

A new fund manager is the biggest risk to a record built by one person, and a strategy change, merger or sharp rise in assets under management matters too, especially in small- and mid-cap funds where size hurts, Gupte added.

When should investors avoid investing or exit an equity fund?

Gupte advised investors to avoid fresh investments if a fund has consistently underperformed both its benchmark and peers, or if the fund manager or investment strategy has changed.

Garg outlined when investors should pause fresh investments or consider exiting an equity fund.

Consider exiting when persistent underperformance against the benchmark and peers coincides with weaker downside protection or changes in management or strategy, Gupte added.

He said, “Don’t wait for long-term numbers to catch up, because they follow trouble rather than predict it. Equally, a single bad year alone is not grounds to exit, since panic selling after one weak year can be costly.”