Investor returns depend on two decisions: the fund you pick and what you do after you pick it.
Research suggests most investors get at least one wrong. Morningstar’s Mind the Gap 2025 report shows investors trail the very funds they invest in by about 1% annually over a decade—not because they chose poorly, but because they acted at the wrong times.
To see how this plays out in Indian equities, we analysed 18 flexi cap funds with over a decade of history. The findings show where investors should focus.
Fund selection created enormous variance. The best performer delivered nearly 5% annual alpha over the benchmark. The worst trailed by 4%. That means the better fund compounds with a 9% spread every year. When this gap compounds over more than a decade, investors in the better fund could end up with nearly three times more money as someone in the worst performing fund, starting with the same amount.
But the data also showed something useful: 14 of the 18 funds beat the benchmark over the full period. Only four did not. Picking well was less about identifying that one superstar, which is harder than it looks without hindsight, and more about avoiding the consistent laggards.
The harder problem is what comes next. Even having picked well, periodic underperformance is the norm.
We calculated the percentage of rolling one-year periods during which each fund trailed the benchmark. The best-performing fund in our analysis spent a quarter of the decade underperforming. An investor tracking its performance would cringe once in every four periods. Other solid performers spent a third of their time trailing.
On average, even the outperforming funds underperformed 40% of the time. The experience of holding an active fund includes long stretches where it feels like a mistake.
To test the impact of reacting to those periods, we simulated a “reactive” investor. They exited when their fund trailed the benchmark by more than 5% over a rolling year, moved into the index, and re-entered when the fund beat the benchmark by 5%.
Before taxes, switching was like a coin toss: the reactive investor beat buy-and-hold in nine funds, lost in eight, and tied in one.
After applying India’s 12.5% long-term capital gains tax on each exit, buy-and-hold won in 17 of the 18 funds. The only exception was the worst performer in the dataset.
Each exit crystallized gains and restarted the compounding clock. Investors paid taxes, feeling like they were doing something.
But this is not an argument for holding on blindly. The disposition effect, a well-documented behavioural bias, shows we are prone to holding losers too long, not just selling winners too early.
The four funds that trailed the benchmark consistently underperformed 70-78% of the time. The pattern was persistent and visible. The risk is not only reactive selling during temporary slumps; it is also stubbornly holding when evidence has accumulated against a fund.
The distinction between style drought and process failure matters. A value fund trailing in a momentum-driven market is the former. The style is out of favour; the process may be intact. This is when patience is appropriate, and often when it is hardest. A fund drifting from its stated mandate, or one that spends most of its time underperforming across market conditions, is the latter. That warrants action.
Fund selection decisions do not need to be all-or-nothing. When doubts arise, consider adding rather than switching. A partial allocation to a fund with a different investment philosophy acknowledges you might be wrong, or that markets might evolve in ways that favour a different approach.
You avoid the certain tax cost of exiting while still acting on your conviction. Start small. Observe how the new fund behaves under different conditions. Notice how you feel holding it.
The aim is not to predict which worldview markets will reward next. It is to make decisions investors can live with over time.
The returns a fund generates are only half the story. The returns investors keep depend on distinguishing discomfort from evidence, and knowing when to stay, when to add, and when to leave.
Anoop Vijaykumar is Head of Equity at Capitalmind AMC