The shocking truth behind ‘best mutual fund’ rankings

Every investor has seen them: glossy ads, financial websites, and magazines boldly declaring the “Top 10 Best Mutual Funds to Invest in Right Now.” These rankings often drive investor decisions, with retail savers flocking to the so-called best performers.

But behind the glossy labels lies a shocking truth: most mutual fund rankings are deeply flawed, biased, or outright misleading. They often serve the interests of fund houses and distributors, not investors. What looks like objective research is, in many cases, just clever marketing disguised as financial advice.

Why “Best Fund” Rankings Exist

1. Easy Marketing Hook
   Investors love lists—they’re simple and confidence-inspiring. “Top 5” sounds easier than reading a 50-page fact sheet.

2. Distributor Influence
   Rankings drive inflows. Distributors and platforms benefit from higher commissions on certain funds.

3. AMC Pressure
   Fund houses lobby rating agencies and portals to highlight their products prominently.

4. Short-Term Memory
   Rankings are often based on 1-year or 3-year returns, which say little about long-term sustainability.

How Rankings Mislead Investors

1. Survivorship Bias

• Funds that underperform are merged or shut down. Rankings only show survivors, creating an illusion that most funds do well.

2. Timeframe Tricks

• A fund that did well in one bull run gets ranked “Best.” Over 10 years, it may lag behind peers.

3. Category Confusion

• Rankings compare funds from different categories (large-cap vs small-cap), skewing performance numbers.

4. Expense Ratio Blindness

• Rankings rarely adjust for high costs. A fund may look good in raw returns but leave investors poorer after fees.

5. Star Ratings Illusion

• Agencies often assign stars (1–5). But these ratings mostly measure past performance volatility, not future returns.

6. Pay-to-Play

• Some financial websites give “best fund” slots to AMCs that advertise heavily on their platforms.

Case Studies

1. India: Small-Cap Mania (2017–2018)

• During the small-cap rally, many funds topped rankings.

• Retail investors piled in, only to suffer 40–50% drawdowns in the 2018–2019 correction.

• Rankings did not warn about higher risk.

2. US: Morningstar’s 5-Star Trap

• Funds with 5-star ratings attracted massive inflows.

• Studies later showed many 5-star funds underperformed the market in subsequent years.

• Morningstar admitted star ratings are descriptive, not predictive.

3. Debt Funds in India (2019–2020)

• Some credit risk funds were ranked as “best debt funds” because of high short-term yields.

• When IL&FS and DHFL defaults hit, these funds collapsed, shocking investors who thought they owned safe products.

Why Regulators Struggle

1. Rankings = Free Speech
   AMCs argue that portals and agencies have the right to publish opinions.

2. No Standardization
   Each ranking body uses its own metrics, making comparisons meaningless.

3. Retail Blindness
   Most investors don’t read disclaimers stating “past performance is not indicative of future results.”

Consequences for Retail Investors

1. Performance Chasing
   Investors jump into last year’s winners, often at the peak.

2. Hidden Risks
   Funds ranked “best” may have concentrated, illiquid, or high-risk portfolios.

3. Disappointment & Exit
   Once returns disappoint, retail investors panic and exit at a loss.

4. Cycle Repeats
   They then chase the next ranking list—fueling a costly cycle.

The Ethical Reflection

The biggest ethical breach lies in presenting rankings as scientific truth rather than marketing content. Retail investors believe rankings are objective, while in reality they are:

• Timeframe cherry-picked,

• Fee-ignorant,

• Influenced by AMC marketing budgets, and

• Poor predictors of future performance.

In other words, the “best fund” label often benefits AMCs and distributors—not the investor.

How Investors Can Protect Themselves

1. Look Beyond Rankings
   Study consistency over 7–10 years, not just 1–3 years.

2. Check Risk Metrics
   Examine volatility, drawdowns, and sector concentration.

3. Watch Expense Ratios
   A high-cost fund rarely stays “best” for long.

4. Diversify Across Categories
   Don’t put all your money in whichever category is currently ranked highest.

5. Be Wary of Ads
   If a ranking appears alongside heavy AMC advertising, assume bias.

Conclusion

The shocking truth behind “best mutual fund” rankings is that they often hide more than they reveal. Instead of guiding investors toward genuinely strong funds, rankings reinforce short-term biases, protect AMC interests, and drive inflows where they’re most profitable—not most prudent.

For regulators, the challenge is to enforce transparency on how rankings are calculated. For AMCs, the duty is to avoid misleading promotions. And for investors, the takeaway is clear: don’t chase stars and top-10 lists—build discipline, diversify, and think long-term.

Because in mutual funds, the “best” today is rarely the best tomorrow.

ALSO READ: Is the S&P 500 manipulated by big money?