Hot funds look great — until they're not
- Robin Powell
- May 8
- 5 min read
Updated: 3 days ago
Hot funds often attract a rush of investor cash. But new research shows they’re more likely to underperform once they’ve hit peak popularity. Here’s why chasing recent winners could leave you trailing the market.
We see it all the time in the investing world: a fund shines with impressive returns, climbs the charts quickly, grabs the media spotlight, and draws in a wave of excited new investors.
But often, this surge in popularity signals the start of a downturn rather than lasting success. Many jump on the bandwagon, only to be let down as the fund’s performance fades.
The idea that popularity guarantees future profits is misleading and can hurt your financial health. Research shows that chasing after the hottest funds is usually a bad idea.
The false comfort of a recent winning streak
Popular funds catch our eye because of their strong recent returns. We naturally trust numbers and feel safer following the crowd. But this comfort can be misleading.
Jeffrey Ptak from Morningstar recently looked in detail at how or otherwise the most popular funds go on to perform. Ptak defined “most popular” funds as those in the Morningstar Categories that saw the biggest inflows (as a percentage of their assets) over a rolling three-year period. He then compares how these funds performed during their boom years with how they fared in the three years that followed.
The results are striking: in more than 80% of cases, the funds’ average returns actually fell after their period of peak popularity.
The chart below captures the core of Ptak’s findings. It shows, side by side, the average returns for the most popular fund categories during their three-year surge, and then how those same categories performed in the following three years. In most cases, the subsequent returns are noticeably lower-sometimes dramatically so. The chart makes it clear: popularity is no guarantee of lasting performance.
Crucially, Ptak’s findings is that they apply across different asset classes:
Equity funds: The most in-demand stock fund categories saw their average returns drop by about 4% per year in the three years after their popularity spike. In fact, these top categories earned only about half as much as other equity funds during those periods.
Sector equity funds: The pattern is even more dramatic here. For example, the hottest sector funds (like energy and precious metals) posted spectacular inflows and strong returns leading up to mid-2016. But in the next three years, their average annual return plummeted to just 0.4%, while less popular sector funds gained around 10% per year.
Fixed-Income funds: Even among bond funds, the most popular types underperformed their peers in the years that followed, though the gap was slightly narrower.
Backed by decades of evidence
Decades of academic research back up Ptak’s findings. Many studies show that highly popular mutual funds tend to perform worse after their peak:
Morey (2003): Funds with 5-star Morningstar ratings saw sharp performance drops within three years.
Massa and Yadav (2010): Funds with strong investor buzz experienced a 3.8% annual drop in risk-adjusted returns, worsening to 5.8% in bubbly markets.
Greene and Stark (2016): "Trendy" funds consistently lagged behind less popular ones over five years.
Choi and Zhao (2020, 2021): The link between past and future returns has weakened or disappeared recently.
Simply put, today's hot fund often becomes tomorrow’s disappointment.
Why it happens
So why does chasing popularity usually backfire? A few factors play a role.
First, recency bias makes us overvalue recent winners, assuming their streak will continue. But short-term returns don’t reliably predict the future. As more money floods popular funds, asset prices get pushed up, limiting potential gains.
Second, herd behaviour causes big inflows that create challenges for fund managers. They might be forced to buy overpriced assets or stray from their strategy, which often hurts returns.
Third, popularity can shift managers’ focus toward marketing and chasing trends instead of sticking to long-term plans. Research shows this often leads to worse performance.
The cost of following the herd
Chasing what's popular doesn't just risk lower returns; it also means missing out on undervalued funds that could outperform.
Ptak’s research highlights that top-selling fund categories often lag behind less popular ones within the same asset class after their popularity peaks.
Take sector funds in infrastructure and energy: they drew big inflows but delivered little in returns afterward, while less popular sectors gained about 10% annually.
Funds that lost their spark
In the UK, several funds have seen this rise-and-fall pattern:
Fundsmith Equity: Managed by Terry Smith, it was hugely popular due to strong long-term results but has underperformed the MSCI World Index for four years since 2021.
Baillie Gifford American Fund: Focused on disruptive growth stocks, it faced big losses when sentiment shifted, with many investors buying at the peak suffering underperformance despite recent recovery.
Jupiter European Fund: Once a favourite, it has struggled due to regional issues, management changes, and high fees, delivering less than half the sector average.
T. Rowe Price Global Technology Equity Fund: Attracted investors seeking tech exposure but faltered due to poor stock choices, volatility, management changes, and high fees.
These examples aren’t meant to single out these funds but to illustrate that even popular funds can have rough patches. Chasing past success can be risky.
Rules to stick to
Rather than chasing the latest popular fund, take a thoughtful, evidence-based approach:
Choose low-cost index funds, which often outperform actively managed ones over the long term.
Focus on diversification, risk management, and aligning investments with your overall portfolio instead of reacting to headlines or star ratings.
Pay attention to valuations. Strong recent performance rarely lasts forever.
Avoid emotional decisions driven by hype or fear of missing out.
Adopt a critical mindset: don’t avoid popular funds blindly, but assess whether their success is sustainable or already priced in.
Resist the lure of the latest fads
Popularity in funds often turns out to be a misleading mirage rather than a sign of future success. Morningstar’s data and decades of research tell a clear story: funds at their popularity peak are more likely to stumble later.
This is driven by psychological biases and the challenges managers face handling surges in demand.
So next time a top-performing fund catches your eye, pause and consider the evidence. In the long run, investors are almost invariably better off with cost-efficient, diversified portfolios that focus on long-term fundamentals instead of following the latest fads.
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