Top Performing Mutual Funds Keep Changing: Why Chasing Last Year’s Best Fund Can Backfire

A mutual fund appears near the top of a return chart. It has beaten its benchmark over the last one or three years, the fund manager is receiving attention and fresh money begins flowing into the scheme. To an investor, the conclusion can feel obvious: this manager has found a winning formula.
Then the rankings change. Another fund moves to the top, the earlier winner slips toward the middle and investors are left wondering whether its manager has lost the touch.
Usually, the explanation is less dramatic. The market environment may have changed, the fund's investment style may have gone out of favour, valuations may have moved against it or the portfolio may have become harder to manage after a surge in assets. A manager can make sensible decisions and still underperform for a period.
This creates the real difficulty in active mutual fund investing. Producing alpha in one market phase is possible. Producing it repeatedly across different market cycles, after costs, is much harder. The investor then faces a second challenge: identifying the manager capable of future outperformance before that outperformance appears in a return chart.

What Is Alpha in Mutual Funds?

Alpha is often used as a complicated investment term, but the basic idea is simple. It is the return a fund generates over and above an appropriate benchmark, although a formal calculation can also adjust for the amount and type of risk taken.

Fund B illustrates why a high return is not automatically evidence of fund manager skill. If the market segment in which the fund invests rose even faster, the investor may have been better rewarded by simply holding the benchmark, before considering the costs of an investable index fund.
This distinction becomes especially important in a strong bull market. A 25% return can look excellent in isolation, but it is not alpha if the relevant benchmark returned 30%. Investors therefore need to separate three questions: how much did the fund earn, how much did its benchmark earn and how much risk did the fund take to produce its result?

How Many Active Mutual Funds Beat Their Benchmarks?

The latest available SPIVA India Scorecard, for the year ended December 2025, shows how sharply the answer changes by category and time horizon. SPIVA compares active funds with category-appropriate benchmarks and includes funds that were later merged or liquidated, reducing the survivorship bias that can make historical results look better than the experience investors actually faced.

Percentage of Indian active equity funds underperforming their benchmarks

Source: S&P Dow Jones Indices, SPIVA India Scorecard Year-End 2025. Data are as of December 31, 2025. The table shows the percentage of funds outperformed by the relevant index based on absolute returns and equal-weighted fund counts. Index returns are total returns in Indian rupees. Active fund returns are after expenses but exclude loads and entry fees.
The mid- and small-cap result contains the article's most important lesson. In 2025, only 12.1% of active funds in the combined category underperformed, meaning nearly 88% beat the S&P India SmallCap over that one-year period. Yet over the ten years ending December 2025, 79.0% underperformed.
Both findings can be true. Active managers may find substantial opportunities during a particular market phase, but the managers who win, the source of their advantage and the conditions supporting that advantage can change. The ability to generate alpha at some point is not the same as the ability to deliver persistent alpha.
Large-cap funds and ELSS funds tell a different short-term story. In 2025, 75.0% of active large-cap funds and 69.2% of ELSS funds lagged their respective SPIVA benchmarks. The category matters, but so do the market conditions inside that category.

Why Beating the Market Once Is Easier Than Doing It Repeatedly

Every active fund has a set of preferences, whether they are stated explicitly or visible through its portfolio. One manager may favour fast-growing companies, another may look for undervalued businesses, while a third may prioritise quality, balance-sheet strength or downside protection. Some portfolios are concentrated, while others spread their risk across many holdings.
These approaches do not work equally well at the same time. Growth can lead in one period and value in another. Smaller companies can outperform for several years and then fall sharply. A concentrated portfolio can look brilliant when its largest positions work, but the same concentration can deepen underperformance when leadership rotates.
SPIVA found a clear example of this change between 2024 and 2025. Five of the six S&P India BMI sectors that had beaten the broader index in 2024 went on to underperform it in 2025. Energy, Financials and Materials moved from laggards in 2024 to outperformers in 2025, while the spread between the best- and worst-performing sectors exceeded 39 percentage points in 2025.
A manager positioned for the previous winners could therefore fall behind without suddenly becoming less intelligent or less diligent. A sound investment process can experience temporary underperformance when its style is out of favour. The real test is whether the process remains coherent, the risks remain controlled and the portfolio behaves broadly as investors were told it would.

Why Do Top-Performing Mutual Fund Rankings Keep Changing?

Fund rankings are snapshots. They capture the interaction between a portfolio and one chosen period, but they do not tell investors whether the same conditions will continue.
The changing one-year SPIVA results illustrate how quickly the environment for active management can shift. These numbers do not rank individual schemes. They show how the proportion of active funds beating a benchmark changed from one calendar year to the next.

Source: S&P Dow Jones Indices, SPIVA India Scorecards Year-End 2024 and Year-End 2025. Each figure covers a separate calendar year, so the table is designed to show changing conditions rather than a continuous multi-year return.
The mid- and small-cap reversal is particularly revealing. The S&P India SmallCap gained 27.5% in 2024, when 53.6% of active funds lagged it. The benchmark then fell 7.9% in 2025, while only 12.1% of active funds underperformed. SPIVA noted that a tilt toward relatively larger, blue-chip companies may have helped active mid- and small-cap portfolios in 2025.
This is why a number-one rank should not be treated as a permanent league-table position. A fund can rise because its style has entered a favourable cycle, because a few large holdings performed exceptionally well or because it took more risk than its peers. None of these automatically makes the performance meaningless, but each requires a different interpretation.

Investors Must Identify the Winner Before It Wins

There are two separate hurdles in active fund investing. First, the fund manager must beat the benchmark after costs. Second, the investor must identify that manager before the future outperformance occurs.
Most investors discover a fund only after it has produced a strong return, appeared on comparison screens, received a higher rating or attracted media attention. Strong performance often brings large inflows, so the fund may also be managing a very different asset base by the time a new investor enters.
This creates a behavioural trap. Investors buy what has recently worked because the evidence feels reassuring, but the purchase is made after the exceptional period has already occurred. If market leadership then changes, the investor experiences the weaker phase without having participated fully in the earlier gains.
Past performance is still useful. It can show how a fund behaved during falling markets, whether it remained true to its style and how consistently it beat or lagged the benchmark across different starting dates. It becomes dangerous only when it is used as a direct forecast.

Why Can Mutual Fund Alpha Disappear?

Alpha rarely vanishes for just one reason. Several forces can work together, which is why investors need to look beyond a fund's return number.

The market learns quickly

Large, widely owned companies are followed by analysts, institutions and sophisticated investors. When new information becomes available, many participants act on it, which can close an obvious pricing gap quickly. A fund manager is not competing against the index as if it were a person. The manager is competing against the collective decisions of everyone else trading those securities.

Market leadership changes

A portfolio built around growth, value, quality, momentum or smaller companies will not behave like the entire market in every period. Its difference from the benchmark is the source of potential alpha, but it is also the source of underperformance when the chosen style falls out of favour.

Costs create a recurring hurdle

Research teams, fund administration and portfolio management cost money. AMFI explains that these operating costs are charged through the total expense ratio and deducted before the scheme's NAV is reported. SEBI also requires separate expense and return disclosures for direct and regular plans because their costs, and therefore their returns, differ.
The manager consequently needs to add enough value to overcome the fund's expenses and trading costs before the investor receives net outperformance. A small gross advantage can disappear after this hurdle. This does not make active management ineffective, but it raises the level of skill required for persistent alpha.

Success can create a capacity problem

A larger AUM does not automatically make a fund worse. Capacity depends on the strategy, the liquidity of its holdings and the size of the opportunity set. A large-cap strategy can generally absorb more money than a concentrated strategy investing in less-liquid smaller companies.
The risk appears when rapid inflows make the original process harder to execute. The manager may have to spread money across more stocks, move toward larger companies, hold more cash or take longer to build and exit positions. Morningstar describes capacity as the point at which asset growth begins changing the opportunity set, portfolio construction or trading behaviour, rather than one universal AUM threshold.

Portfolio rules limit even the best ideas

Mutual funds operate within scheme mandates, diversification requirements and liquidity constraints. A manager cannot place unlimited money in one idea, even with very high conviction. If a small number of heavyweight benchmark stocks drive index returns, an active fund that owns less of them can lag despite reasonable performance across the rest of its portfolio.
Competition also matters. Once many managers identify the same opportunity, buying pushes up the price and reduces the future return available from it. A genuine insight can therefore be valuable without remaining valuable forever.

Does This Mean Active Mutual Funds Do Not Work?

No. The 2025 mid- and small-cap result itself rules out such a simplistic conclusion. Nearly 88% of active funds in SPIVA's combined category beat the benchmark during that year.
Active managers may have more room to differentiate themselves where analyst coverage is thinner, company quality is more dispersed and liquidity varies widely. They may also add value through risk control, avoiding weak businesses or holding portfolios that fall less in difficult markets. However, less-efficient segments can also carry higher governance, liquidity and valuation risks.
The evidence therefore supports a more balanced conclusion. Opportunities for alpha exist, and active managers can exploit them during particular periods. The opportunity does not guarantee that the same manager will keep winning across market cycles, nor does it tell an investor in advance which manager will capture it.
The question is not whether active management works in theory. It is whether a specific fund has a repeatable process, appropriate capacity, reasonable costs and risks that the investor understands.

Why Survivorship Bias Can Make Past Performance Look Better

Imagine judging a ten-year competition by looking only at the participants still present at the finish. Funds that merged, closed or disappeared would be excluded, even though they were part of the choices available to investors at the beginning. This is survivorship bias.
SPIVA includes these non-surviving funds in its starting universe. Across the five Indian categories in its report, 27% of funds failed to survive the ten years ended December 2025. Within equity, ten-year survivorship was 79.4% for large-cap funds, 75.6% for ELSS funds and 88.7% for mid- and small-cap funds.
This does not mean every fund that disappeared was a failure, since schemes can merge or change for different reasons. It does mean that looking only at today's surviving funds can give investors an incomplete view of the original selection problem.

How Should Investors Evaluate an Active Mutual Fund?

The answer is not to ignore returns. It is to use returns as evidence about the fund's behaviour rather than as a promise about its future.

1. Compare the fund with the right benchmark. A large-cap fund should not be judged against a small-cap index or against a category that took materially different risks. Check both absolute return and benchmark-relative return.
2. Use rolling returns, not only one point-to-point period. A five-year point-to-point return uses one start date and one end date. Five-year rolling returns test many such periods, helping reveal whether outperformance occurred repeatedly or depended on one favourable entry point.
3. Study full market cycles. Look at how the fund behaved in rising, falling and sideways markets. A defensive fund may lag during a sharp rally but protect capital better in a downturn, while an aggressive fund may show the opposite pattern.
4. Check the risk taken to earn the return. Concentration, exposure to smaller companies and large sector bets can increase both upside and downside. Higher return produced through much higher risk should not be mistaken automatically for superior skill.
5. Match the record with the current fund manager. A ten-year scheme return is less informative if the present manager has run the portfolio for only two years. Also check whether the investment team and decision-making process have changed.
6. Understand the investment style. Investors should know whether the fund prefers growth, value, quality, momentum or a blended approach. This makes temporary underperformance easier to interpret and reduces the temptation to exit solely because another style has started leading.
7. Watch for changes in the portfolio and AUM. Rising AUM is not a sell signal. However, rapid growth accompanied by more holdings, market-cap drift, higher cash or a visible change in portfolio construction deserves investigation.
8. Examine costs and turnover. Compare expense ratios on a like-for-like basis, including direct plan with direct plan. High turnover can also create trading costs that are not fully captured by looking only at the stated expense ratio.
9. Focus on process consistency. The most useful question is whether the fund continues to do what it said it would do. A repeatable process is not a guarantee of alpha, but a changing or poorly explained process makes the outcome even harder to assess.

No single metric can identify tomorrow's winner. The objective is to build a body of evidence about how the fund makes decisions, what risks it takes and whether its outcomes are consistent with that process.

Active Fund or Index Fund Is Not the Only Question

The active-versus-passive label can distract investors from the more useful questions. What exactly are you paying the active manager to do? Has the fund added value across several rolling periods or mainly during one favourable phase? Did it take materially more risk to generate the excess return? Has the process remained stable as the fund and its AUM changed?
Recent outperformance is evidence of what happened. It is not proof of what will happen next. A fund's place at the top of a one-year or three-year chart may reflect skill, style, risk, a favourable market cycle or a combination of all four.
The goal should therefore not be to buy last year's number-one fund. It should be to choose a fund whose investment process, costs and risk profile are understandable, repeatable and suitable for the investor's portfolio. Persistent alpha is valuable precisely because it is difficult to produce and even harder to identify in advance.