During a bull market, so-called ‘high return’ mutual fund schemes dominate headlines and investor conversations. A fund that has delivered sharp gains over the past year can look irresistible when compared with the relatively modest returns offered by bank fixed deposits or debt schemes.
But strong recent performance does not automatically make a fund suitable for long-term wealth creation. In many cases, investors end up entering just when the cycle is peaking.
High returns and sustainable returns are not the same. Before allocating fresh capital, investors should dig deeper into the risks taken to generate those returns.
Here are 10 key warning signs to watch out for.
Many investors judge a fund purely on its 1-year return. This can be misleading.
Markets move in cycles; a rally in small caps, PSUs or a specific theme can temporarily boost returns
Short-term out-performance does not reveal behaviour during corrections
Consistency across cycles matters more than a single-year spike
Check multi-year CAGR, rolling returns and performance during past downturns before investing.
Some high-return funds rely on concentrated bets.
Top 5–10 holdings accounting for a large share of the portfolio increases stock-specific risk
Heavy exposure to one sector or theme raises volatility if that theme cools off
True diversification is about balancing risks across sectors and businesses, not just holding many stocks.
A fund classified as large cap should predominantly invest in large-cap stocks. However, in pursuit of higher returns, managers may increase exposure to mid or small caps.
This alters the risk profile of the scheme
Investors expecting stability may unknowingly face higher volatility
Review the market-cap allocation and compare it with category norms to check whether the fund is sticking to its mandate.
In a strong bull market, valuation discipline can weaken.
Returns driven by valuation expansion rather than earnings growth are fragile
If earnings fail to justify high multiples, sharp corrections may follow
Check whether portfolio stocks are trading well above historical PE or PB averages. Future returns may already be priced in.
The portfolio turnover ratio indicates how frequently a fund buys and sells stocks.
An unusually high turnover may signal aggressive trading
Excessive churn increases transaction costs
It may reflect reactive management chasing momentum
Long-term wealth creation generally benefits from stability and conviction.
When a fund delivers exceptional returns, AUM often rises rapidly.
Sudden inflows can be challenging, especially for mid and small-cap funds
Deploying large sums in less liquid stocks becomes difficult
It may lead to performance dilution or liquidity risk
Assess whether AUM growth has been gradual or sudden. Scalability is crucial in niche or thematic strategies.
Strong performance in rallies is only half the story. The real test lies in corrections.
Does the fund fall more than its benchmark during downturns?
Has it recorded large maximum drawdowns in the past?
What is its downside capture ratio?
Large losses require disproportionately higher gains to recover.
Absolute returns can be deceptive.
Standard deviation measures volatility
Sharpe ratio assesses returns relative to risk
Beta shows sensitivity to market movements
A fund with slightly lower returns but superior risk-adjusted metrics may be better suited for long-term investors.
Some high-return funds are heavily tilted towards fashionable themes such as defence, manufacturing or digital plays.
Thematic cycles can be sharp but short-lived
Exit timing becomes critical
Investors should ensure thematic exposure fits within their overall asset allocation plan.
Historically, investors enter funds after strong performance and exit after corrections.
Media hype and widespread enthusiasm can signal elevated expectations
Buying at peak sentiment increases the risk of near-term disappointment
Disciplined investing focuses on process, valuation comfort and allocation discipline — not recent excitement.
High-return mutual funds can play a role in wealth creation. But strong past performance should prompt deeper analysis, not blind allocation. Investors would do well to prioritise consistency, risk management and alignment with long-term financial goals over headline-grabbing returns.
