How to mitigate the recency bias of investors in mutual funds?

The advisor's panel at Moneycontrol Mutual Fund Summit 2024.

A major chunk of inflows into Indian equity mutual funds have been tilted towards sectoral/thematic and small-cap funds, which have performed really well over the past one year. Experts at the Moneycontrol Mutual Fund Summit suggested that this recency bias of investors must be addressed for better wealth generation experience by investors.

Data available with the Association of Mutual Funds in India (AMFI) shows that so far in this financial year, sectoral/thematic funds category have received the highest inflows among the equity mutual funds at around Rs 65,000 crore. Further, small-cap funds have witnessed net investments of Rs 9,300 crore.

Mutual fund industry experts have been warning that investing in mutual funds that have performed well in the recent past can lead to disastrous results for investors.

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One such example is inflows into Information Technology (IT) funds during calendar years 2021-2022, which was based on stellar returns given by such funds during 2020 and 2021. However, returns tapered off after that.

Focus on rolling returns

To address this recency bias, Misbah Baxamusa, Chief Executive Officer (CEO), NJ Wealth suggested that industry should stop using point-to-point returns of mutual schemes, especially on a one-year basis. “When you see good returns over one-year, two-year or three-year good, investor starts building expectations that same would be repeated over a longer period of period of time,” he said.

One way this could be addressed as per Baxamusa is by start highlighting rolling returns.

Simply put, rolling returns show you how a fund has performed consistently over a long period of time. Point-to-point returns do not show consistency in mutual funds.

“We give a lot of emphasis on rolling returns and especially rolling returns of five years or 10 years, even though the number of funds with that 10-year rolling returns are relatively small,” he said.

According to Baxamusa, another benefit which comes out of focussing on rolling returns is that expectations of investors can be managed.

“If you see rolling returns of Nifty 50 of more than 10 years, you will see a number of around 12.8 percent. So, a fair expectation of returns from investments starts building in when you start seeing rolling returns,” Baxamusa said.

Stop focussing on assets

Indian asset management companies are usually ranked based on their asset under management (AUM). It was only in December 2023 that the Indian mutual fund industry’s AUM hit the Rs 50 trillion mark — a doubling of assets in four years. The industry is expected to continue on its growth trajectory.

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As of July end, the AUM of Indian mutual fund industry is around Rs 65 trillion.

Talking during the advisors’ panel at the Moneycontrol Mutual Fund Summit, Kailash Kulkarni, CEO, HSBC India Asset Management was of the opinion that a major change in behaviour of investors will be seen if AMCs being ranked on the basis on their AUM is stopped.

“If we stop ranking AMCs on AUM and start ranking them in terms of new customer added per year and publish that ranking, you see there'll be a behaviour change. The 4.5 crore mutual fund investors level will become 20 crores in the next two years, Kulkarni said.

“The beauty about ranking in terms of totally new customers that AMCs have added in the industry is that it gives 43rd AMC a chance to become number 1 for 2025, and the number 3rd AMC might become number 37 if they hadn’t added investors,” said Kulkarni.

Importance of handholding

Suresh Sadagopan, SEBI RIA, MD & Principal Officer, Ladder7 Wealth Planners, believes that the mutual fund industry has done quite well till this point on a product-based selling.

“If you want a growth from here onwards, it has to be a client-centric advisory based approach. The returns are not really that very relevant. What is truly really relevant is whether the clients are able to run their life the way they want, meet the goals that they want. We need to take a fiduciary approach,” Sadagopan said.

Kulkarni, meanwhile, also highlighted the importance of hand-holding or quality advice while investing in mutual funds.

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“On an investment platform, which is a pure tech platform, there's no handholding. Investors may struggle during bad times, because you can't cry on a laptop. You need a shoulder to cry on. So, whether you are an RIA (Registered Investment Officer) or an MFD (mutual fund distributor), you have a role to play in terms of managing the client. And we are far short of the number of people we require,” said Kulkarni.