Sectoral funds dominate 2024 investments: Does chasing hotshot MFs work?

Investing can often feel like navigating a maze, especially when you hear about high-performing funds that deliver eye-catching returns. But should you chase after the year's hottest fund or stick with a more straightforward, reliable approach? In the latest fund performance analysis, analysts at Value Research explore the difference between high-growth "hot funds" and simpler, long-term strategies often referred to as the “KISS” (Keep It Simple, Stupid) fund. 

 

The Year’s Hottest Fund: Big Gains with Big Risks

The hottest fund of the year is the sectoral theme which has caught the attention of many investors with substantial short-term returns. The fund typically targets high-growth sectors like technology or emerging markets, which have the potential to deliver strong performance during a market upswing. According to the analysis, the top performer this year posted an outstanding  return, significantly outpacing other funds and attracting attention across the market.

 

However, with high returns come higher risks. These funds are heavily invested in sectors or stocks that can be volatile, which means their value can swing wildly. A sharp market correction or change in sector performance could result in significant losses just as quickly as gains. The short-term excitement is undeniable, but this kind of fund may not be the best choice for investors seeking stability or long-term growth.

 

The KISS Fund: Steady and Reliable Performance

On the flip side, there is the KISS fund approach. Instead of targeting volatile high-growth sectors, the KISS fund follows a simple, straightforward strategy, typically focusing on well-diversified large-cap stocks and bonds. These funds tend to provide steady, consistent returns over the long term, making them ideal for investors who prefer less volatility and a safer approach to wealth-building.

 

The KISS strategy works by investing in a balanced mix of solid, reliable assets—often large, well-established companies with a track record of delivering returns, regardless of market fluctuations. While such funds may not deliver the explosive returns that the hottest funds can, the KISS fund strategy is far less risky and can still generate solid returns over time. 

 

The analysis uses two distinct scenarios to highlight how your investment could grow over time based on different strategies.

 

Scenario 1: Switching to the Hottest Fund Each Year

In this scenario, you start with an investment of Rs 10 lakh in 2005. Every year, you switch your investment to the top-performing fund of the previous year. The idea here is to capitalize on momentum, assuming that the best-performing fund from the previous year will continue to deliver strong results in the following year.

 

So, you’re constantly chasing the "hottest" fund—thinking you’ll always catch the next big winner. However, this approach is risky. You’re constantly moving in and out of different funds, and the returns depend entirely on how well the top fund performs each year.

 

Over a 20-year period, this strategy would grow your Rs 10 lakh investment to Rs 3.32 crore. This sounds good, but it’s not as reliable or predictable as a simpler approach. The risk here is that the fund you choose one year might not perform well in the next year, or the performance could be inconsistent, leading to missed opportunities and higher volatility.

 

Scenario 2: The Keep-It-Simple-Silly (KISS) Strategy

In this scenario, you take a more straightforward approach. You invest the same Rs 10 lakh in 2005, but instead of switching funds every year, you choose a solid, well-performing fund (one that’s known for stable, long-term growth) and hold it for 20 years.

 

The strategy here is simple—buy and hold. You’re not constantly chasing the latest trends or trying to time the market. By sticking to a consistent, reliable fund over the long term, you avoid the hassle of switching and worrying about short-term market fluctuations.

 

With this approach, your Rs 10 lakh investment would grow to Rs 3.92 crore over 20 years. Not only does this yield a higher return compared to the fund-switching approach, but it’s also much less stressful and less risky. The KISS strategy benefits from compounding returns, the core principle of long-term investing.

 

What Does the Data Say?

Looking at real-world performance, this year’s hottest fund might have made waves with its impressive growth, but the KISS fund has consistently outperformed over the long term. The analysis of funds over the past decade shows that high-risk funds (like the hottest fund of the year) often experience sharp peaks followed by deep troughs. In contrast, KISS funds have delivered steady growth, averaging better risk-adjusted returns. This means while the hot fund may show a big return one year, the KISS fund will likely provide a more reliable growth pattern over several years.

 

Going from being the top performer to being a poor performer in just 12 months is real. Value Research's data analysis shows the following:

•  Eight of the last 20 toppers sank to the bottom half of the table in the next year. 
• Even when funds stayed above average, their ranks dropped dramatically: from 1st to an average of 40th the following year. 

 

If you look at the trends across categories, here's what Value Research found: 

• Flexi-cap funds: Six of 20 toppers delivered below-average performance the next year. 
• Value-oriented funds: Seven of 20 toppers had similar declines. 
• Large & mid-cap funds: Eight toppers fell significantly.

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"Don't get tempted by the domination of sectoral and thematic funds . 11 of the last 20 toppers were either sectoral or thematic funds. That's because when they do well, they are terrific. But predicting when they'll do well is like a lottery. And if you are jumping on a sectoral and thematic fund based on last year's result, good luck. That's because investors often buy into sectoral funds at their peak, only to watch them plummet.

 

Then, there's the tax bite . Each time you switch funds, you're triggering a tax event. Sell your fund within a year? Expect a 20 per cent tax on your gains. Even if you hold for over a year and your gains exceed Rs 1.25 lakh, you'll still be slapped with a 12.5 per cent tax. Hence, the more you switch, the more tax you pay. That's annoying because it erodes your hard-earned returns," said Ashish Menon and Abhishek Rana of Value Research in a note.

 

Why is the stick-to-few-funds strategy better?

Menon believes consistency beats flashy winners as funds that have the highest 20-year returns rarely top the annual charts. "For instance, HDFC Flexi-cap Fund —an all-star performer in its category—gained the number 1 ranking just once in the last 20 years," said Menon. 

 

Rana thinks investors should look for a fund's long-term track record and choose a fund that has consistently performed over time. They're better equipped to handle market ups and downs and deliver steady returns.

 

"Opt for diversified funds like flexi-cap funds and multi-cap funds . Even large and mid-cap or value-oriented funds. Such diversified funds reduce the impact of any one fund or sector underperforming," said Rana.