The Illusion of the “Top Ranked” Mutual Funds & How should Investors select Funds

What if I told you that chasing the #1 mutual fund almost guarantees lower returns?
We analyzed a decade of flexi-cap data, and it revealed a surprising pattern most investors completely miss.
We conclude by guiding what criteria should investors be looking at while selecting Mutual Funds.

Introduction

Every year, mutual fund ranking tables create excitement among investors.

Financial websites publish lists such as:

• “Top 10 mutual funds of the year”
• “Best performing equity funds”
• “Number one mutual fund in 2025”

Investors naturally assume that the fund at Rank #1 must be the best choice. But the data tells a very different story.

When we examine the last decade of performance of flexi-cap mutual funds, something surprising emerges:

• Each year had a different fund at rank one
• Hardly any fund managed to remain the top performer for two consecutive years
• In many cases, the previous year’s topper fell sharply in rankings the next year

This simple observation highlights a powerful lesson: Short-term rankings in mutual funds are extremely unreliable indicators of future performance.

Before we go on to prove the futility of chasing top ranked mutual funds by showing your real data from the last decade, let us understand the methodology we are using:

Methodology

• Category analyzed: Flexi-Cap Funds
• Return measure: Calendar year returns
• Plans used: Direct Plan - Growth option
• Data source: Value Research Online / Morningstar
• Ranking: Based on annual returns within the category

Top Performers Every Year

Based on the above methodology, we looked at the flexi-cap mutual fund category over the past decade and listed the # 1 ranked Mutual Fund every year

What you observe from the above table is that across 10 years:

• Funds keep changing their Rank # 1 almost every year
• It is tough, almost impossible, to predict who the next Rank # 1 would be.

This means chasing last year's winner would not have helped investors stay with the best fund.

Where did the top performers go?

But what happened to the top-ranking fund of a particular year in the next year. Did they fall to Rank 2 or 3? That is an even more interesting question. 

To study the change in not just the absolute ranks but their relative ranking within the community of flexi cap funds, we used a very special methodology so that you can get the feel of change.

We created a 10-Year Ranking Matrix of all the top performers. This matrix visually demonstrates how mutual fund rankings jump between quartiles across years. But before we can understand this Ranking Matrix, we need to first get conversant with what a Quartile is, and why are quartiles a better than exact rankings.

What is a Quartile?

Instead of showing exact ranks (1st, 5th, 12th etc.), this analysis groups funds into quartiles. Quartiles simply divide the entire category into four equal groups.

If the category has 40 funds, the quartiles look like this:

Why Quartiles Are Better Than Exact Rankings

Using quartiles is actually more meaningful than showing exact ranks, and that is for many reasons:

(1) Avoids False Precision

The difference between Rank 3 and Rank 6 may be just 0.5% return difference. But rankings make the gap look huge. Quartiles avoid this false precision and show the broader performance band.

(2) Makes Long-Term Patterns Clear

If we plotted exact ranks across 10 years, the chart would look noisy. Quartiles simplify the view:

• Quartile 1 [Q1] means strong performance
• Quartile 2 [Q2] means above average
• Quartile 3 [Q3] means below average
• Quartile 4 [Q4] means weak performance

This makes performance migration easier to see.

(3) This Is the Method Used in Academic Research

Most academic research on mutual fund performance persistence uses quartiles or deciles.

This allows researchers to analyze questions like:

• How many Top Quartile funds stay Top Quartile next year?
• How many Bottom Quartile funds remain laggards?

Annual Quartile Position of Mutual Funds

Here is the annual quartile position of Mutual Funds over the last 10 years and the matrix tells you quite a lot

The above Quartile Position Matrix clearly demonstrates the following:

Rankings Move Dramatically

A fund in Top Quartile (Q1) one year often moves to Q3 or Q4 pretty soon.

As an example, 
1/ Parag Parikh Flexi Cap Fund ranked 46 out of 51 funds in 2017 within its category despite being considered a high-quality long-term fund.

2/ Parag Parikh Flexi Cap was in Q1 in 2020 and moved to Q4 in 2022. This means the fund moved from top 25% to bottom 25% within two years.

3/ HDFC Flexi Cap moved from Q1 in 2017 to Q3 in 2018.

and so on...

No Fund Dominates Every Year

Across the decade, every fund appears in all four quartiles at different times. Even well-known funds alternate between top and average rankings

This reinforces an important reality that Mutual fund leadership rotates frequently.

Short-Term Rankings Reflect Market Phases rather than fund leadership

Flexi-cap funds differ in style - some tilt large cap, some favor midcaps, some follow value investing, and others are more momentum oriented - and of course a dynamical changing combination of all these and many more factors.

When market leadership shifts, rankings shift as well. This is why calendar-year returns often mislead investors.

This demonstrates that short-term rankings fluctuate widely even for strong funds. 

In a category with about 40 funds, roughly 10 funds are in the Top Quartile each year. But historical persistence studies show that only about 2–3 of them remain in the Top Quartile the next year. This makes chasing last year’s winners a poor investment strategy.

Real Example with Real Data

Now, let us get number crunching with real numbers.

Let us consider the case of two investors - Investor A and Investor B.

Investor A looks at the #1 ranked fund every year and then invests in that fund.
Obviously, he gets the return from that fund only by the next year.
So, if Investor A saw that a Fund X has ranked # 1 in 2017, and he starts to invest in it based on the ranking, his investments fetch him the 2018 returns for that fund.

Investor B, on the other hand, has picked a good long-term performer and he just sticks with that investment - irrespective of yearly ranking of his / her fund, even if the fund dips to the bottom rank.

Let us start crunching the numbers with real data.

But before we go with number crunching, it is important to highlight the assumptions we make for the numbers

Assumptions:
1. The data analysis period is 2016 to 2025. 
2. Year 2020 has been excluded - it being a Covid outlier.

3. Calendar Year (and not Financial Year) returns are considered for each year (for simplicity).

4. Data is downloaded from Value-Research website
5. All Flexi Cap funds have been analyzed except for relatively new funds (which did not exist on or before 2019)
6. Starting investment amount of Rs. 1,00,000 is assumed - both with Investor A and B. 
7. Investments are done in Direct Growth flexi cap mutual funds.
8. The balance at the end of Year 1 is fully invested at the beginning of Year 2 (there is no break in compounding) 

Example

Here is the year wise result of these two investors - one who switches to the #1 Fund every year and the one who stays invested in any decent long-term performer and does not care about the rankings.

Both Investor A and Investor B start with an initial corpus of Rs. 1,00,000
So, let me explain you how the investment philosophy of both the investors worked:

Investor A

• Investor A looked at the 2016 best performing fund (known only at the end of 2016), which was Aditya Birla Sun Life Flexi Cap Fund with a 2016 calendar year return of 16.24%. 
• He invested his Rs. 1,00,000 in this fund in 2016.
• Next year i.e. 2017, this same fund yielded a return of 35.07%.
• So, the balance of Investor A at the end of 2017 was Rs. 1,35,070
• Then, Investor A realizes that in spite of a 35.07% returns in 2017, this fund is not performing as well, since there is a new number 1 performer in 2017, which is Edelweiss Flexi Cap Fund with a 2017 return of 47.90% return.
• Investor A feels he is in a wrong fund. He feels cheated. He comes out of Aditya Birla Sun Life Flexi Cap Fund and invests his Rs. 1,35,070 into Edelweiss Flexi Cap Fund at the end of 2017. By the end of 2018, he experiences that this new fund yielded a pathetic -3.62%. So, his new fund balance at the end of 2018 becomes Rs. 1,30,180.
• And the cycle continues...
• By the end of 2025, after switching to the "best ranked" fund every year, the Investor A ends with a corpus of Rs. 3,55,966

Investor B

• Investor B decides not to look at the ranks.
• He decides to look at long term strong funds and picks up a good fund based on his understanding. He picks up Parag Parikh Flexi Cap Fund (an example with HDFC Flexi Cap Fund is also given).
• He invests his Rs. 1,00,000 in Parag Parikh Flexi Cap Fund in the end of 2016 and does not disturb the money until the end of 2025 - even if this fund was a poor performer for a few years.
• By the end of 2025, without making any switch, the Investor B ends with a corpus of Rs. 3,85,322 (~8.25% higher than Investor A)
• If Investor A had picked up HDFC Flexi Cap Fund instead of Parag Parikh Flexi Cap Fund, he would have ended up with a corpus of Rs. 4,31,199 (~21.1% higher than Investor A)

Learnings from the Example

• Chasing ranks in mutual funds is a myth. It is an illusion that a top ranked fund is good.
• Rankings change every year and the best funds of one year can prove to be the worst in the very next year
• Market cycles and black swan events rule
• It is far better to stick to a decent performer and stay with it during its ups and down.

Two Important Considerations

• You observed how Investor B ended up richer than Investor A by selecting any decent fund and then doing nothing. Less action rewards more often. This is one of the FOOPS! moments - as you would have read in the FOOPS! book

• Remember that when Investor A switches every year from one fund to another, he/she also pays the Long-Term Capital Gains tax that breaks the compounding. His corpus at the end of next year is actually lesser than what we have assumed in the example. Switching funds in lure of better returns becomes futile even if there is a guarantee of better returns in the new fund. Read more about this in our blog: The Hurdle Rate of Switching Investments

How to pick a long-term decent fund

Investor B selected Parag Parikh Flexi Cap Fund or an HDFC Flexi Cap Fund. So, selecting funds still matters.

But the objective should not be to predict the next topper. Instead, focus on the investment process and consistency.

Here are some useful guidelines:

Look at Long-Term Performance

• Evaluate at least 5 to 7 years of performance.
• This ensures the fund has seen all phases - Bull markets, bear markets and sideways markets

Study Rolling Returns

• Instead of point-to-point returns, look at 3-year rolling returns.
• This answers an important question - How frequently does the fund beat its benchmark?
• Funds that beat the benchmark 70% or more of the time demonstrate strong consistency. These metric measures performance persistence, and not just occasional brilliance.

Evaluate Quartile Consistency

• Instead of focusing on rank #1, evaluate how frequently the fund stays in the top half of the category.
• Over the past 5–7 years, the fund should be in Top 2 quartiles (Q1 or Q2) most of the time.
• This means it is consistently above average. This is far more important than occasionally being #1.

Study Downside Behavior

• A good fund is not only about high returns. One must also look at maximum drawdown, performance during market crashes, and overall volatility
• Look at performance during 2020 crash, 2022 correction, and earlier corrections if available
• Funds that fall less during bear markets often compound better over time.

Evaluate Risk Adjusted Returns

• High returns alone are not enough. Look at risk-adjusted metrics.
• Some of the key indicators are Sharpe Ratio (Return per unit of risk), Sortino Ratio (Downside risk efficiency) and Standard Deviation Volatility.
• Good long-term funds generally show higher Sharpe ratios than category average.

Understand the Investment Philosophy

• The fund should have a clear and consistent investment philosophy.
• As an example, if the philosophy is value investing, then the fund should stick to the same for most of the years. 
• Funds with clear philosophies often show more stable long-term performance.

Check Portfolio Stability

• Avoid funds that constantly churn their portfolios.
• Look at Portfolio turnover ratio. Typical range for long-term investing funds is 20%–50%
• Very high turnover often indicates short-term trading behavior of the fund manager.

Check Asset Size (AUM)

• AUM matters but only to a limited extent.
• A general guideline is to avoid extremely small funds since they may carry a liquidity risk.
• Prefer funds with ₹5,000 - ₹30,000 crore AUM.
• This range usually balances stability with flexibility.

Check Fund Manager Tenure

• Consistency improves when the same manager runs the fund for long periods.
• Look for minimum 4 to 5 years tenure.
• Frequent manager changes introduce strategy shifts.

You may not be able to match all criteria as listed above but if you find a fund with majority of the above, you are in for a decent wealth creation without hopping funds.

Summary

Every year, mutual fund ranking tables highlight the “top performer”, tempting investors to shift their money to the latest winner. 

But data from the flexi-cap category shows that leadership changes constantly - the #1 fund in one year rarely stays at the top the next year. In fact, many previous toppers quickly slip to average or even bottom-quartile positions. This happens because market phases rotate and different investment styles come in and out of favor. 

Instead of chasing rankings, investors should focus on funds that demonstrate long-term consistency across market cycles. Evaluating rolling returns, downside behavior and process discipline is far more useful than reacting to annual performance tables. 

In investing, staying with a consistent fund usually works better than chasing the latest topper.

Regards

Manoj Arora

Official Website