The curious case of the “Top 5” fund investor

A 5 minute read

In our earlier posts here and here we had explored the reasons why going only by past returns is not a great way to pick equity funds.

However despite all that being said, there is still a strong inherent instinct in all of us (that includes me as well) to lean towards funds which topped the charts in the recent times.

Most of the times in the past, our instincts have stood us well in other areas.

So should we trust our instinct in fund selection as well?

Image result for In God we trust. All others must bring data

Err.. Ok Mr Deming. As per your wish, I will bring the data 😩

The Intuitive Fund Portfolio

How do most of us select our equity fund portfolios?

Simple just select the top 5 funds of the last 1 year!

But this keeps changing. No worries. We seem to have sorted that out as well.

After every 1 year (no tax..hurray!!), we will change the funds to the top 5 funds of the past 1 year. Simple!

So here is the exact plan:

Image result for new year party

On every new year after our parties are over and we become sober, we shall select the top 5 diversified equity funds (no sector, thematic, etf, index, international, balanced blah blah) based on their performance for the year and let it run for a year till the next new year party. Eg On 1-Jan-16 we would have selected the top 5 funds of 2015. On 1-Jan-17 we would replace it with the top 5 funds of 2016. And so on..

This will be our Intuitive Fund portfolio strategy

Image result for intuitive investing

How do you think this strategy would have performed in the last 10 years? (i.e between 01-Jan-2007 till 01-Jan-2017)

Let us check.

The Intuitive Fund Portfolio gave 10.8% compound annualized returns

But is this bad, good, ok-ish. How do we judge ??

Lets add 1 more data point..

Nifty gave 8.1% compound annualised returns


Intuitive Fund Portfolio’s 10.8% significantly outperforms Nifty’s 8.1%

So case closed.

But hang on.. What about the performance vis-a-vis other funds?

The 10Y returns of the 95 diversified funds that existed for last 10 years is 10.8%

Oh Shit. That means our Intuitive fund portfolio’s performance is not awesome.
It’s rather barely OK-issh.

Some more sad news.

Out of the 95 funds, a whopping 50 funds outperformed our Intuitive fund portfolio 😩

Its not over. Here is the final  nail in the coffin..

Image result for nail in the coffin

Now instead of picking the top 5, let us assume you were a little high post your new year party and by mistake ended up picking the 5 performers from bottom pile instead of top pile every year (In this case I have assumed you chose funds that were ranked from 76-80 every year).

Believe it or not. This strategy actually beat our Intuitive fund portfolio.

You heard that right – the portfolio of 76-80th ranked funds gave a 10Y return of 12.5% vs 10.8% for our Intuitive portfolio

To put that in perspective..

10 lakhs invested in the portfolio of 76-80th ranked funds would have become 32.4 lakhs vs 28 lakhs for our Intuitive portfolio.

That is a staggering difference of  4.4 lakhs!!
(A foreign trip + Royal Enfield Classic 350 + Iphone 7 + Bose speakers + some lavish weekend outings..Phew)

Image result for vacation baliImage result for classic 350 wall paperImage result for apple iphone 7

Phew..So the next year when you see the top performers of 2017 article in the newspapers – you know what to do about it.

Yawn and move on!

Now, one thing is pretty clear – selecting the top funds every year based on performance and changing them every year is definitely not a great strategy

But I am sure, your pattern seeking mind is upto something. (if not..then here is the hint – didn’t I mention that the funds ranked 76-80 every year outperformed the intuitive portfolio)

Eureka!! How about following this strategy of picking the bottom funds instead?

Interesting. So let us test this out against all combinations i.e funds ranked 1-5,6-10,11-15 and so on.

Here are the ten year returns for the different strategies:

All strategies Performance -1.png

The top 5 strategies have been highlighted in blue. The best performing strategy was picking the funds ranked 46-50 every year. It gave around 13.4%.

But if instead you had picked the funds ranked 41-45 every year, you would have been the worst performer in the last 10 years.

So for all those, who were looking to derive some insights from past short term performance, I have some disappointing news.

The performances across the strategies as seen above are simply random. So neither the bottom 5 or top 5 is a fool proof strategy (or for that matter any “position of ranking” strategy).

Fund Selection is hard work

All these, point towards a simple conclusion:

Fund selection, whether we like it or not, unfortunately is hard work.

Image result for hard work

While past returns over long term (say greater than 7 years) may still form an important input for fund selection, we also need to start appreciating other important predominantly qualitative nuances such as fund manager’s investment philosophy, process, investment style, investment strategy, consistency in performance, fund house credentials, behavior during bad times, ability to stick to process, communication etc

To get a glimpse of how to evaluate fund managers you can refer here

In the coming weeks , we will explore on what might be leading to this strange phenomenon of top 5 funds under performing and also if fund ratings (which are primarily based on performance) are a good way to pick funds.

And just in case you like the contents,

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For the curious ones, these were the funds that went into our intuitive portfolio every year

Top 5 Strategy.png

Source: Value Research

Disclaimer: All blog posts are my personal views and do not reflect the views of my organization. I do not provide any investment advisory service via this blog. No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments



Mental Models – Authority Bias

10 minute read

The Mac Donald Strip Search Prankster..

Recently I happened to watch an extremely disturbing movie called “The Compliance”.

You can watch the trailer here:

It’s a movie based on a real life incident, which took place in the US,  where a prank caller posing as a police officer, convinces the manager of a fast food restaurant to carry out a strip search on a female employee and also to perform other bizarre sexual acts on behalf of “the police”.

If you are up for some sleepless nights, you can watch the entire movie here

And for those who don’t have the time, the story goes like this..

It was a busy late afternoon at Mc Donalds in a US suburb. The duty manageress receives a telephone call from the prankster who poses himself as a police. The prankster describes one of the McDonald’s young female employees and requests that the manageress summon her to the office.

He then informs her that it was suspected that her employee had committed a serious crime and because the police were busy and short staffed it would save time if the duty manageress could carry out an official police-led interrogation. The manageress is also informed that the store manager had agreed to this procedure along with a McDonald’s executive.

As the restaurant was too busy for the manageress to complete the task, she calls her  fiancee from his home to help. Then over a period of some three hours, the fiancé is exhorted by the policeman over the phone to question, strip search and sexually abuse the employee.

And he obediently does exactly what he is told. All in the name of the law.

Further, she is also forced to perform lurid sexual acts – all as per the instructions from the prankster faking as the policeman on the phone.

Image result for mcdonald strip search prank

When interviewed after the event both the manageress and her fiancee shockingly claimed that they were only following orders!

The sad part is that over 70 such occurrences were reported in 30 U.S. states, until an incident in 2004, finally led to the arrest of the prankster David Richard Stewart.

But how does the prankster manage to pull this off??

I have exactly the same question that is running in your mind..

Why in the world would the manageress obey the extreme and bizarre instructions from the policeman?

Is it this easy to lead people into to such inhumane behavior?

Mr Stanley Milgram had the same question..

Fortunately for us, there was another US psychologist in 1950s called Stanley Milgram who was plagued by a similar question.

Image result for stanley milgram

As the world witnessed millions of Jews getting killed by the Germans under the leadership of Hitler, Milgram was stumped on how could so many Germans support and obey the madman.

Rev Leslie Hardman in Belsen







An then comes this outrageous defense from the perpetrator of Nazi Holocaust..

A handwritten request for clemency by Adolf Eichmann, an architect of the Nazi Holocaust, who said he shouldn't be held responsible for his actions because he and other low-level officers were following orders from their superiors. A new study released Thursday offers one reason why people can be easily coerced into carrying out heinous orders. Photo by Ammar Awad/Reuters
The above is the handwritten letter in 1962 for clemency by Adolf Eichmann, an architect of the Nazi Holocaust, who said he shouldn’t be held responsible for his actions because he and other low-level officers were just following orders from their superiors.

Milgram was perturbed and wanted to prove a hypothesis –

Germans have a basic character flaw which explains the holocaust, and this flaw is a readiness to obey authority without question, no matter what outrageous acts the authority commands.

So in 1961, he set about with his now famous experiments which tested if “ordinary” folks would inflict harm on another person after following orders from an authoritative figure.

But the results of his experiments had a scary conclusion..

The problems wasn’t with the Germans, it was with us – humans!!

The participants were paid well for their participation in what was described to them as an experiment on learning and memory. Each participant who was selected was assigned the role of a teacher in a memory test, and was required to ask a series of questions via intercom to another person (played by an actor set up by Milgram) who sat in the next room.

If the learner got the answer wrong, the participant had to administer an electric shock. With each mistake made, the participant was instructed to administer progressively higher shocks (the shock would increase by 15 volts).

Related image
As the voltage increased, the learner (who in reality was getting no shocks at all) started to complain. Post the first shock the learner grunted in pain, but as the voltage increased, his protests and yells became more vehement. At 150 volts, he yelled that he wanted to be released, and at 240 volts he shouted that his heart is in acute pain and pleads to stop. Once the shocks reached the range designated as ‘extreme intensity’ on the machine, he screamed in anguish, and soon after fell silent faking unconsciousness.

When the participant expressed concern about giving the shocks, the researcher asked them to continue.

Here comes the killer:

Despite the obvious shouts indicating the learner’s pain and, in many cases, the participant’s own agitation and stress..

A massive 65% of participants followed the instructions and progressed through to administer the full 450-volt shock!

Image result for milgram quotes

Image result for milgram quotes

Several versions of the same experiment has been run multiple times till date.

And unfortunately each and every time it  was the same conclusion.

Even when participants show that they disagree with administering the shocks, when the authority figure tells them they must continue, they often do so.

This strange phenomenon of blind obedience to authority goes a long way to explain why normal people would follow the orders of the likes of Stalin or Hitler.

The bottom line of the story..

People have a significant tendency to obey authority; even if the instructions make them disagree, uncomfortable or unhappy

From phone scams, holocausts to airline is everywhere..

On December 28th, 1989, United Airlines flight 173 was about to land at Portland International Airport when it experienced a landing gear problem.

The captain decided to delay the landing and stay some more time in the air so that he could troubleshoot the problem. However, the flight had a second problem – dwindling fuel.

But sadly, the first and second officers in the cockpit, due to their deference to the authority of the captain, were unable to get him to focus on the real problem facing the troubled airliner – the craft’s rapidly shrinking fuel supply.  Instead, the captain was obsessed with trying to solve a possible problem with the airplane’s landing gear.

In the crash that followed, two crew members and eight passengers died from the 189 people on board.

Instead of questioning the decision of the captain, the flight crew yielded to his authority and let the plane run out of fuel, despite being aware of what could happen.

Yet another tragedy. The reason remains the same – Blindly following Authority.

(However the good part is that the airline industry was quick to learn from the issue and  as a solution started using a NASA-developed program known as Cockpit Resource Management. Essentially, the program makes sure that crews are trained in a way that everyone has a say in identifying problems and solving them.)

Welcome to the world of Authority bias

Robert Cialdini, one of the world’s leading experts in the science of persuasion also identifies “Authority bias” as one amongst the 6 powerful principles of persuasion.Image result for robert cialdini


Now you know the reason why I quote so many experts 🙂

Why should we bother?

Sub consciously most of us will have a natural tendency to be more influenced by the opinion from an Authority.  And this is an extremely scary thought, that we must get comfortable at.

The authority could be from experience, reputation, or just simply a title. It might come from anywhere – our boss, an investment expert on TV, an experienced co-worker, a person with a higher designation, a doctor,a lawyer, people with perceived power such as policeman, politician etc.

So the next time you are making a critical decision or taking instructions from an authority, think – Mr Hitler, the McDonald’s prankster and Flight 173.

Authority bias in the world of investing

As expected, the authority bias is prevalent in the world of investing.

Most of us get carried away by market predictions and opinions of so called investment experts.

The key is to keep reminding us that just because it comes from a reputed investor or an investment expert it doesn’t necessarily have to be true.

We need to concentrate on their arguments rather than their position, and should be open to challenge the claims they make.

And if this gives you some solace, investment experts have not had a great record in predicting the future (read here).

So the next time you see someone on the TV with the next big investment idea.

Before you get excited and start investing – Pause and Think!!


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Disclaimer: All blog posts are my personal views and do not reflect the views of my organization. I do not provide any investment advisory service via this blog. No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments