Mutual funds have become a popular investment choice for individuals seeking to diversify their portfolios and gain exposure to various asset classes. Mutual fund investments are thought to be an excellent choice for individuals looking for wealth accumulation that beats inflation and is tax-efficient.

However, the performance of mutual funds can be negatively impacted by various risks, such as market risk, credit risk, liquidity risk, interest rate risk, and inflation risk.

Before investing in mutual funds, investors consider various factors, including alignment with their goals, investment horizon, and risk tolerance. Constructing a portfolio around a few wisely selected, worthy mutual fund schemes is possible. However, a few of these funds occasionally fail to outperform the benchmark.

There may also be instances in which a mutual fund investment proves to be a significant letdown. And this underperformance worries us every time we review our portfolio. You may keep wondering – Why my mutual funds are not performing well? What is the reason behind the same?

Well, let us try to understand the whole idea of why mutual funds fail…

You see, despite their widespread popularity, mutual funds can sometimes underperform their benchmarks. This underperformance can be attributed to a variety of factors, including fund manager skills, investment strategy, dynamic market conditions, etc.

Here are some reasons contributing to mutual fund underperformance:

1. Poor Investment Strategy

The investment strategy of a mutual fund can significantly impact its performance. Some funds may pursue aggressive growth strategies to maximise returns by investing in riskier assets. While this approach can potentially lead to higher returns, it also carries a higher risk of underperformance.

Some mutual funds may adopt more conservative strategies suitable for risk-averse investors, prioritising capital preservation over high returns. However, such strategies may result in lower returns and reduce the underperformance risk.

Consequently, the success of a mutual fund is closely correlated with the performance of its underlying securities. Depending on the economic prospects, fund managers can diversify their holdings across industries, market capitalisations, asset classes, and other factors. The impact of a market downturn may be low if the fund portfolio is well-diversified and hedged.

[Read: Should You Invest in Nifty Index Funds as Large Cap Mutual Funds Underperform?]

2. Performance of the Fund Managers

Every actively managed mutual fund scheme has a dedicated fund management team that works towards the portfolio management of the fund. As a result, a fund’s performance is highly dependent on the performance of the fund management team.

The skills and experience of a fund manager play a crucial role in determining the scheme’s success. A skilled manager can effectively analyse the market, identify promising investment opportunities, and make sound investment decisions. Conversely, a manager with less experience or skill may make poor investment choices that can lead to underperformance. Therefore, the choices and approaches made by fund managers will significantly affect how well a fund performs.

An ideal approach is that fund managers regularly assess and analyse the fund’s portfolio and make the required corrections. Investors may consider choosing the best suitable mutual fund schemes managed by a qualified fund management team with a track record of success. A skilled fund manager can navigate complex conditions and protect investors’ money.

3. Dynamic Market Conditions

Mutual fund performance is also influenced by overall market conditions. Even though one may have chosen a fund with a proven performance track record, it is difficult to predict the market conditions.

Even well-managed funds may experience underperformance during market volatility or downturns. This is because the value of their underlying investments may decline, leading to a decrease in the fund’s Net Asset Value (NAV).

[Read: Why Mutual Fund NAVs Are Going Down and the Investment Strategy to Follow Now]

For example, market fluctuations causing a recession, hikes in interest rates, etc., also affect your mutual fund investment. Even the best funds take a hit in these turbulent times. On the other hand, if government policy changes impact a particular sector or industry, the fund’s performance may also suffer.

Timing the markets is one thing you should never do; the more you attempt, the higher the chances of losing your capital. Therefore, if you possess the basic knowledge of picking the right fund, then there is not much worry about the market’s uncertain ups and downs. All you have to do is exercise patience and hold onto your investments until you notice a consistent underperformance.

4. Investment Based on Past Performance

The market performance of mutual funds can be judged on the basis of endurance during downtimes and outperformance during the right times, which are the characteristics of the top funds. There is nothing wrong in judging mutual funds on the basis of the past performance. However, the question arises about what is the duration you are looking at while analysing past performance.

Investing in mutual funds based on high returns in the short term is not considered a wise choice. For instance, there may be funds that performed well for the last 3-6 months but had failed earlier. Market volatility can sometimes lead to short-term gains, but these gains can also be quickly wiped out.

[Read: Are Your Equity Mutual Funds Generating Alpha Returns?]

Investors may be tempted to chase high returns, which can lead to them making impulsive investment decisions. However, it is all about consistency that matters here to identify the underperforming Mutual Fund.

Instead of analysing the past 6 months’ performance, one should look at the fund’s 3-year or 5-year track record. This will tell if the fund was able to sail well through the various market cycles and interest rates fluctuations or if it is a consistently underperforming mutual fund.

Especially for equity mutual funds, giving sufficient time for the fund to perform is very significant. These funds may not show results in the short term, but it may hold good potential in the long run.

5. Investment Based on Star Ratings

Although mutual fund star ratings are a widely used tool for evaluating mutual fund performance, there are several reasons why you may not invest in mutual funds solely based on their star ratings.

Star ratings are based on past performance, which may not be indicative of future results. A fund that has consistently received high star ratings in the past may not continue to perform well in the future.

To understand how mutual fund ratings work and whether or not they are reliable watch this video!


Star ratings do not consider important factors such as the fund’s investment strategy, fees, and risk profile. These factors can all have a significant impact on a fund’s performance. Some rating agencies have been criticised for their methodology, and some funds have been accused of manipulating their ratings.

Investors may be tempted to chase high star ratings, but instead of relying on star ratings, you may do your own research before investing in a mutual fund. One may consider the fund’s investment strategy, expense ratio, risk profile, and historical performance and ensure the fund aligns with your investment goals.

Table: Mutual funds underperformance across equity-oriented categories

Scheme Performance Absolute (%) CAGR (%)
1 year 3 years 5 years 10 years
Mid cap mutual funds
Best performing schemes 38.05 38.82 27.12 24.53
Worst performing schemes 14.13 19.20 16.49 19.18
Category average 29.16 27.96 20.66 21.50
% of schemes underperforming vis-a-vis benchmark 46.67% 61.53% 54.16% 35.01%
Flexi cap mutual funds
Best performing schemes 30.17 33.71 25.16 23.83
Worst performing schemes 10.05 13.69 11.13 11.81
Category average 19.28 20.47 16.47 17.03
% of schemes underperforming vis-a-vis benchmark 24.24% 52.00% 37.50% 17.64%
Large cap mutual funds
Best performing schemes 21.16 25.77 17.05 17.95
Worst performing schemes 7.82 11.42 11.37 12.06
Category average 13.90 17.50 14.68 15.02
% of schemes underperforming vis-a-vis benchmark 12.90% 25.00% 26.92% 24.01%
Benchmark Indices
Nifty Midcap 150 – TRI 33.89 30.45 21.38 21.75
S&P BSE 100 – TRI 11.62 17.86 14.82 14.51
NIFTY 100 – TRI 9.10 16.47 14.11 14.27
S&P BSE 500 – TRI 14.73 20.03 15.95 15.68
NIFTY 500 – TRI 15.10 19.87 15.79 15.58

Data as on November 22, 2023
Past performance is not an indicator of future returns.
(Source: ACE MF, data collated by PersonalFN Research) 

Comparing a mutual fund’s performance to its benchmark index can reveal underperformance. If a fund consistently lags behind its benchmark, it may be underperforming.

As you can see from the above table, a significant number of funds have not been able to outperform the respective benchmark index in the last 1 year to 5 years period. Flexi cap and Mid cap funds had the highest number of schemes underperforming the benchmark, followed by large cap funds.

The underperformance of mutual funds could be due to several factors, including rising interest rates, inflation, geopolitical concerns, slow economic growth, etc. However, it is important to remember that past performance does not necessarily indicate future results.

Despite the underperformance of these categories, it is important to remember that mutual funds are long-term investments. The equity market has always been volatile, and there could be periods of underperformance. However, over the long term, the equities are known to offer significant returns. Investors who can stay invested through periods of underperformance are likely to be rewarded in the long run.

To mitigate the risk of mutual fund underperformance, investors may consider adequate portfolio diversification, right asset allocation, periodic monitoring, and seeking professional advice.

[Read: Why You Should Declutter and Consolidate Your Mutual Fund Portfolio]

Usually, when a mutual fund begins to perform poorly, many investors withdraw their money from the scheme and prefer to exit, but are they really required to do so…

What is the ideal time to exit from an underperforming mutual fund scheme?

It’s crucial to bear in mind that all investments come with a level of risk; when you invest in equity mutual funds, be prepared to see short-term market swings. The volatility of your fund will vary depending on the category and market conditions.

That being said, if a mutual fund is persistently underperforming and failing to meet its objectives, it may be time to reconsider the investment. The exit decision may not be based solely on past performance. Every investment style goes through phases and may underperform in certain market situations.

Investors may determine if the underperformance stems from a failing investment approach or the fund manager deviating from the stated strategy. Investors shall not make hasty decisions based on short-term fluctuations in performance and re-evaluate their investments if a fund consistently underperforms its benchmark over a period of time.

[Read: How to Strategically Approach Equity Mutual Funds in Volatile Markets]

To conclude…

While mutual funds can offer a convenient and diversified investment opportunity, understanding the factors that contribute to underperformance is crucial for making informed investment decisions.

By carefully evaluating fund characteristics, conducting thorough research, and diversifying effectively, investors can increase their chances of selecting well-performing mutual funds that align with their long-term investment goals.

This article first appeared on PersonalFN here

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