How to Choose a Mutual Fund Using Past Performance (Correctly)

Every January, financial websites publish "Top 10 Mutual Funds of Last Year." NRIs see these lists and think, "I'll invest in these winners."

We see this pattern constantly at Belong. NRIs in Dubai, Abu Dhabi, and across the UAE send us screenshots of funds with 40-50% returns. They want to know if they should invest immediately. Our answer is always the same: those numbers tell you almost nothing about what the fund will do next.

Past performance matters. But most investors read it wrong. They chase last year's winners, buy at peak valuations, and then wonder why their returns look nothing like the advertised figures.

This guide will teach you the correct way to evaluate mutual fund past performance. You'll learn why rolling returns beat point-to-point returns, how to use risk metrics like Sharpe ratio and alpha, and how to spot funds with genuine consistency versus one-year wonders.

Many NRIs in our WhatsApp community have asked these exact questions. We've compiled everything into this single resource.

Why Last Year's Top Performer Often Disappoints

Here's an uncomfortable truth. Top performers are usually concentrated in hot sectors. When that sector corrects, the fund tanks. You're buying at peak valuations after the growth has already happened.

In 2020, tech funds dominated the rankings. In 2021, pharma funds took over. Investors who chased these winners often saw their investments decline when the cycle turned.

This happens because of a concept called "mean reversion." Sectors that outperform dramatically tend to return to average performance over time. When you buy a fund at its peak, you're essentially buying at the worst possible moment.

This year's top-performing mutual funds aren't necessarily going to be next year's best performers. It's not uncommon for a fund to have better-than-average performance one year and mediocre or below-average performance the following year.

👉 Tip: Never invest based on single-year returns. Look at consistency over 3-5 years, not single-year performance.

The Difference Between Point-to-Point and Rolling Returns

Most fund comparison websites show you "trailing returns" or "point-to-point returns." These are the 1-year, 3-year, and 5-year figures you see everywhere.

The problem? The 1-year/3-year/5-year return (which you normally see) aren't useful to understand a fund's performance. These returns show the change in NAV on a single day in one year compared to a single day in another. It does not tell you what happened in between those two dates.

Point-to-point returns are heavily influenced by what happened on the start date or end date. If the market happened to crash on your start date, the fund looks great. If it crashed on your end date, the fund looks terrible.

Rolling returns solve this problem.

What Are Rolling Returns?

Rolling returns are calculated for various market conditions, including bull, flat, sideways, and bear markets. On the other hand, point to point is biased by the market conditions prevalent during the period.

Think of it this way. Instead of measuring performance from January 1, 2020 to January 1, 2023 (one measurement), rolling returns measure performance from January 1 to January 1, then January 2 to January 2, then January 3 to January 3, and so on.

You end up with hundreds of data points instead of one. This shows you how the fund performed across different starting points.

Rolling returns is the best measure of a fund's performance. Trailing returns have a recency bias and point to point returns are specific to the period in consideration. Rolling returns, on the other hand, measures the fund's absolute and relative performance across all timescales, without bias.

How to Use Rolling Returns

When analysing rolling returns, look at:

Here's a quick look at the average rolling returns of some top mutual fund categories in India: Large Cap Funds - 1-year: 22%; 3-year: 15%; 5-year: 12%. Mid Cap Funds - 1-year: 25%; 3-year: 20%; 5-year: 15%. Small Cap Funds - 1-year: 30%; 3-year: 25%; 5-year: 18%.

Use these as benchmarks. If a fund claims exceptional returns but has high percentage of negative periods, the advertised returns may not reflect your actual experience.

You can check rolling returns on platforms like Value Research, Morningstar India, and PrimeInvestor.

👉 Tip: Focus on 5-year rolling returns for equity funds. This period captures at least one full market cycle.

Understanding Risk-Adjusted Returns: Alpha, Beta, and Sharpe Ratio

Returns alone don't tell the full story. A fund that returned 25% sounds better than one that returned 18%. But what if the first fund took twice the risk?

Risk-adjusted returns help you compare apples to apples. Here are the key metrics:

Beta: How Volatile Is the Fund?

Beta = 1 implies the fund tends to move in line with its benchmark. Beta > 1 indicates higher volatility than the benchmark. Beta \< 1 suggests lower volatility than the benchmark.

A fund with beta of 1.2 will rise 12% when the market rises 10%. But it will also fall 12% when the market falls 10%.

For NRIs investing in Indian mutual funds, beta matters because you may not be tracking the market daily. Higher beta means more dramatic swings in your portfolio value.

Alpha: Did the Fund Manager Add Value?

Alpha is the excess returns relative to market benchmark for a given amount of risk taken by the scheme. Alpha in mutual funds is probably the most important performance measures of a mutual fund scheme.

For example, if a fund returned 12% in a year and its benchmark returned 16%, the fund's alpha would be –4. That means the fund underperformed by 4%.

Positive alpha means the fund manager is generating returns beyond what the market offers for the same level of risk. This is what you're paying for when you choose active funds over index funds.

Look for funds with consistently positive alpha over 3-5 years. One year of positive alpha could be luck. Five years suggests skill.

Sharpe Ratio: Return Per Unit of Risk

Sharpe Ratio is one of the most sacred formulas in Finance. It was invented by William F Sharpe, an American Economist in the year 1966. He was awarded the Nobel prize in 1990 for his work the Capital asset pricing model.

The formula is simple: (Fund Return - Risk Free Rate) / Standard Deviation

Higher Sharpe ratio means better risk-adjusted returns. A fund with 18% returns and 0.95 Sharpe beats a fund with 25% returns and 0.55 Sharpe on risk-adjusted basis.

👉 Tip: When comparing two funds with similar returns, always choose the one with the higher Sharpe ratio.

Sortino Ratio: Focusing on Downside Risk

The Sortino ratio is similar to Sharpe, but it only considers downside volatility. This matters because not all volatility is bad. Upward price movements are desirable.

Sortino Ratio gives you a clear picture of how your investment would perform when it matters the most - in times of negative volatility.

For conservative NRIs who prioritise capital protection, the Sortino ratio is often more relevant than the Sharpe ratio.

Benchmark Comparison: Is the Fund Actually Outperforming?

Every mutual fund has a benchmark index. Large-cap funds are benchmarked against Nifty 50 or Sensex. Mid-cap funds against Nifty Midcap 150. Small-cap funds against Nifty Smallcap 250.

Every mutual fund is benchmarked against a specific market index. Check whether the mutual fund has outperformed or underperformed its benchmark over different periods.

If a large-cap fund returns 15% but the Nifty 50 returns 18%, the fund has actually underperformed. You would have been better off with a simple Nifty 50 index fund.

How to Find the Benchmark

The benchmark of a fund is mentioned in the Scheme Information Document (SID) and in the fund's factsheet. Both are typically available on the mutual fund company's website.

When comparing a fund to its benchmark, check:

1. Has the fund beaten the benchmark over 3, 5, and 10 years?
2. Has it beaten the benchmark in both bull and bear markets?
3. Is the outperformance consistent or sporadic?

A fund that beats the benchmark only in bull markets but crashes harder in bear markets may not suit your risk profile.

Expense Ratio: The Hidden Return Killer

For instance, you invest Rs. 25000 monthly through SIP in a mutual fund scheme for 30 years with an expected rate of return of 12%. The accumulated corpus would be Rs 6.3 crore in a regular plan where you are paying a 1.5% expense ratio. 

However, with the direct plan, where the expense ratio is 1%, this accumulated amount would be Rs 7.8 crore. The 0.5% difference in expense ratio could cost Rs 1.5 crore, which is approximately 24% more than the regular plan.

That's not a typo. A 0.5% difference in expense ratio can cost you 24% of your final corpus over 30 years.

Direct vs Regular Plans

Since Regular plans have a higher Total Expense Ratio (TER), they grow at a slightly slower rate every day compared to Direct plans. Over the long term, this small daily difference compounds, leading to noticeably lower returns in Regular plans.

For NRIs who can manage their investments independently, direct plans offer significant long-term savings. Platforms like Belong offer direct plans for mutual fund investments without the complexity.

👉 Tip: Always check if you're investing in the direct or regular plan. The word "Direct" should appear in the fund name.

SEBI Expense Ratio Limits

SEBI regulates mutual fund expense ratios in two ways. One, SEBI specifies the maximum that each category of funds can charge. Two, SEBI defines caps based on the assets under management (AUM) of the fund as well. Expense ratios decline as a fund grows in size.

Larger funds typically have lower expense ratios due to economies of scale. Check if the fund you're considering charges significantly more than category average.

Fund Manager Track Record and Consistency

Past performance is partly about the market. But it's also about the people managing your money.

A fund manager's track record matters, especially for actively managed funds. Ask these questions:

1. How long has the current fund manager been managing this fund?
2. What's their performance across previous funds?
3. Have they delivered consistent outperformance or just occasional spikes?

If a fund's stellar past performance came under a different manager who has since left, those returns are less relevant to your decision.

Many fund houses provide fund manager information on their factsheets. Look for managers with at least 5 years of experience managing similar strategies.

Common Mistakes NRIs Make When Evaluating Past Performance

Mistake 1: Chasing Recent Winners

Focus on consistency over 3-5 years, not single-year performance. Look for funds that delivered top-quartile returns in at least 3 of the last 5 years.

A fund that ranked in the top 25% for three out of five years is more reliable than one that ranked #1 for one year and bottom 50% for the other four.

Mistake 2: Comparing Across Different Categories

Comparing a small-cap fund's returns to a large-cap fund is meaningless. Small-caps are inherently more volatile and tend to deliver higher returns during bull markets.

Always compare funds within the same category: large-cap vs large-cap, not large-cap vs small-cap.

Mistake 3: Ignoring Risk Metrics

One of the most common mistakes is choosing funds based solely on past performance. While historical performance can provide insights, it doesn't guarantee future results. It's crucial to look at the fund's consistency, investment strategy, and the current market conditions rather than just past returns.

A fund returning 30% with high volatility may actually be riskier than one returning 20% with stable, consistent growth.

Mistake 4: Not Accounting for Taxation

For NRIs, taxation on mutual fund returns adds another layer of complexity.

Equity-oriented mutual funds: Gains from the sale of units within 12 months are taxed at 15%. Debt-oriented or other non-equity funds: Gains from units sold within 36 months are added to the investor's income and taxed according to the applicable tax slab.

After-tax returns are what actually reach your pocket. A fund with 15% pre-tax returns might net you less than one with 12% pre-tax returns if the tax treatment differs.

NRIs from UAE can benefit from DTAA provisions to reduce double taxation.

Mistake 5: Forgetting Currency Risk

If you're earning in AED and investing in INR, currency fluctuation affects your actual returns. A fund delivering 12% in INR terms might deliver only 8-9% in USD/AED terms if the rupee depreciates.

This is why many UAE NRIs consider GIFT City investments that offer USD-denominated returns, eliminating currency conversion risk.

A Step-by-Step Framework to Evaluate Mutual Funds

Here's how to systematically analyse a fund:

Step 1: Filter by Category

Decide your investment goal first. Growth? Income? Tax saving? This determines the category.

Step 2: Check 5-Year Rolling Returns

Look for:

• Average rolling return above category average
• Fewer negative periods than peers
• Reasonable minimum rolling return (not catastrophic)

Step 3: Evaluate Risk Metrics

• Alpha: Should be positive over 3-5 years
• Sharpe ratio: Above 0.75 preferred
• Beta: Match to your risk tolerance

Step 4: Compare to Benchmark

The fund should consistently beat its benchmark, especially over longer periods.

Step 5: Check Expense Ratio

Lower is better. Consider direct plans to minimise costs.

Step 6: Review Fund Manager Tenure

Prefer managers with 5+ years on the fund and consistent track records.

Step 7: Confirm NRI Eligibility

Not all mutual funds accept NRI investments, especially from US/Canada due to FATCA regulations.

You can use Belong's Mutual Funds Explorer to find NRI-eligible funds.

Should You Use Index Funds Instead?

Given the complexity of evaluating active funds, many NRIs wonder: should I just use index funds?

Index funds track a benchmark like Nifty 50 without trying to beat it. They have:

• Lower expense ratios (often below 0.5%)
• No fund manager risk
• Predictable, market-matching returns

Better yet, use index funds. They track the market (Nifty 50, Sensex) and avoid the temptation to chase performance.

For NRIs who don't have time to research active funds, index funds offer a simple, low-cost solution. You won't beat the market, but you won't dramatically underperform either.

An Alternative Worth Considering: GIFT City Mutual Funds

For NRIs seeking simpler options, GIFT City mutual funds offer unique advantages:

• No capital gains tax for NRIs/OCIs
• No NRE/NRO account needed
• USD-denominated, eliminating currency risk
• Simplified repatriation

Funds like the DSP Global Equity Fund and Tata India Dynamic Equity Fund are available through GIFT City with tax benefits that traditional mutual funds don't offer.

This doesn't mean past performance analysis isn't important for GIFT City funds. It is. But the tax and currency advantages often make the comparison clearer.

How to Track Your Fund's Performance After Investing

Evaluation doesn't end after investing. Regular monitoring ensures your fund continues meeting expectations.

Check quarterly:

• Is the fund still beating its benchmark?
• Has the fund manager changed?
• Is the expense ratio stable?

Check annually:

• Are rolling returns still competitive?
• Does the fund still fit your asset allocation?
• Should you rebalance?

Many NRIs use Belong's app to track their investments in one place.

Taking the Next Step

Understanding past performance is just one piece of the puzzle. You also need to consider your residential status, tax implications, and repatriation rules.

If you found this guide helpful, join our WhatsApp community where NRIs discuss investment strategies, share experiences, and get answers to specific questions.

You can also explore Belong's suite of tools including our NRI FD Comparison Tool and Compliance Compass to ensure your investments align with regulatory requirements.

Download the Belong app to compare funds, track returns, and invest in tax-efficient options designed specifically for NRIs.

Sources:

• SEBI Mutual Fund Regulations
• AMFI - Association of Mutual Funds in India
• Value Research Online
• PrimeInvestor Rolling Returns Calculator
• Income Tax Department - NRI Taxation