Why Two Mutual Funds in the Same Category Deliver Very Different Returns

Imagine this scenario: You and a colleague decide to start investing for a long-term goal. You both agree that a large-cap equity fund is the safest bet for consistent, inflation-beating returns. You invest ₹10,000 monthly in "Fund A," and your colleague invests the same amount in "Fund B." Five years later, you compare notes. Despite investing in the exact same category, during the exact same economic cycle, your colleague's portfolio is worth significantly more than yours.

If you have ever found yourself asking, "why two mutual funds in same category give different returns?" you are not alone.

Many investors assume that because funds share a category tag, they are practically identical. However, under the hood, mutual funds are incredibly complex engines. While the Securities and Exchange Board of India (SEBI) ensures broad standardisation across categories, the actual engine design—the fund manager's philosophy, stock selection, and risk management—creates massive variance in Net Asset Value (NAV) growth.

Let's pull back the curtain and explore the real reasons why does fund A beat fund B same category, and how you can make smarter, guided decisions for your portfolio.

The Illusion of Sameness: Understanding SEBI's Mandate

In 2017, the market regulator issued a landmark circular to ensure true-to-label mutual funds SEBI compliance. The goal was to stop mis-selling and ensure a large-cap fund actually invested in large-cap companies.

SEBI defined the universe clearly: for instance, a large-cap fund must invest a minimum of 80% of its total assets in the top 100 companies by market capitalization.

However, that leaves a 20% window for the fund manager to invest anywhere—mid-caps, small-caps, debt instruments, or holding cash. Furthermore, within those top 100 large-cap stocks, there is enormous room for interpretation. Should the fund buy IT stocks or banking stocks? Should it buy 20 stocks in large quantities or 50 stocks in smaller quantities? This creative freedom is precisely why same category mutual funds different performance is a reality.

If you occasionally find this terminology confusing, brush up with our comprehensive Mutual Fund Jargon Buster before we dive deeper into the mechanics of fund performance.

7 Reasons Why Two Mutual Funds in the Same Category Give Different Returns

While the category label tells you where a fund is allowed to invest, it doesn't tell you how it will invest. Here are the core drivers of return divergence.

1. Active Share and Fund Manager Skill

The most significant factor driving benchmark-relative alpha (the extra return generated above the market average) is the manager's skill in stock selection.

Some funds are "closet indexers"—they mimic the benchmark index closely to avoid catastrophic underperformance. Others have a high active share, meaning their portfolio looks very different from the benchmark.

If Fund A identifies an undervalued sector before a massive economic boom and allocates heavily towards it, while Fund B completely ignores it, the returns will diverge dramatically. To understand how to measure this skill mathematically, you can read our guide on Understanding Sharpe Ratio, Alpha, and Beta.

2. The Danger (or Genius) of Style Drift

Every mutual fund starts with a mandate, but over time, managers might experience style drift. This happens when a manager shifts their investment philosophy to chase higher returns.

For example, a conservative multi-cap fund manager might suddenly start increasing exposure to highly volatile micro-cap stocks during a bull market. While this might temporarily boost their Compound Annual Growth Rate (CAGR), it entirely alters the risk profile you initially signed up for. If Fund A sticks to its mandate and Fund B drifts, their performance will split. We cover this exact phenomenon in our piece on How to Handle Underperforming Funds in Your Portfolio.

3. AUM Bloat and the "Size Trap"

Assets Under Management (AUM) is a double-edged sword. When a fund performs well, it attracts massive inflows. But there is a point where a fund becomes too big to be nimble.

AUM bloat / size trap is a common phenomenon in Indian mid-cap and small-cap categories. A nimble Fund A with an AUM of ₹2,000 crores can easily enter and exit smaller companies without impacting the stock price. However, Fund B, with an AUM of ₹30,000 crores in the same category, cannot deploy large amounts of cash into small companies without driving the share price up against itself.

Consequently, bloated funds often start behaving like large-cap funds, leading to sluggish returns compared to their leaner peers. Learn more about how to evaluate fund sizes in The Role of Morningstar and Other Ratings in Fund Selection.

4. Portfolio Concentration vs. Diversification Within Category

How many stocks does the fund hold?

• Fund A (Concentrated): Holds 20 to 25 high-conviction stocks. If the manager's bets are correct, the returns will be explosive. If they are wrong, the losses are steep.
• Fund B (Diversified): Holds 60 to 80 stocks. The returns are likely to be smoother and less volatile, but rarely chart-topping.

This strategic choice creates a massive gap in returns, especially over shorter timeframes. When evaluating your own holdings, always check the portfolio overlap same category funds feature. Holding two funds with 80% identical stocks gives you the illusion of diversification without the actual benefits. You can optimize this mix by reading Portfolio Diversification with Mutual Funds.

5. Differences in Portfolio Turnover Ratio (PTR)

The frequency with which a fund manager buys and sells stocks is known as the Portfolio Turnover Ratio. A high PTR means the manager is aggressively trading to capture short-term gains. While this can sometimes work, excessive trading racks up brokerage fees, Securities Transaction Tax (STT), and other hidden costs that drag down the overall return. Conversely, a buy-and-hold manager with a low PTR keeps costs low, allowing the power of compounding to work uninterrupted.

To see how this metric impacts your bottom line, explore our deep dive on Understanding Portfolio Turnover Ratio (PTR).

6. Fund Manager Tenure and Turnover

A mutual fund is ultimately managed by human beings. If Fund A has had the same lead manager for 10 years, there is consistency in the investment philosophy. If Fund B has seen three different fund managers in the last three years, the portfolio is likely in a constant state of churn and restructuring.

Frequent fund manager tenure and turnover often leads to inconsistent returns, as each new manager sells off previous holdings to shape the portfolio to their own liking.

7. Expense Ratio Impact on Returns Same Category

Finally, we must look at costs. The expense ratio is the annual fee charged by the Asset Management Company (AMC) to manage your money.

If two funds have identical gross returns, but Fund A charges 1.8% and Fund B charges 1.0%, Fund B will deliver higher net returns to the investor. While a 0.8% expense ratio differential might seem tiny, it compounds into lakhs of rupees over a 15 to 20-year investing horizon. We discuss how to minimize structural drags on your wealth in How to Choose Tax-Efficient Funds for Your Wealth Goals.

Why Regular Plans and Distributors Make the Difference

Understanding how to compare funds in same category requires looking past past performance. It requires analyzing alpha, tracking style drift, monitoring AUM bloat, and ensuring the fund aligns with your personal risk appetite.

This is where the DIY (Do-It-Yourself) approach often falters. Picking funds based solely on a 5-star rating or last year's top performer is a recipe for a disjointed portfolio.

Investing through regular mutual funds via a registered distributor provides a critical layer of defense. A dedicated Mutual Fund Distributor (MFD) monitors all the metrics mentioned above on your behalf. They conduct periodic portfolio reviews, warn you of style drifts, and ensure your Systematic Investment Plans (SIPs) benefit from rupee cost averaging across market cycles without emotional interruptions. The value of ongoing guidance, goal alignment, and behavioural coaching far outweighs minor differences in expense ratios.

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Frequently Asked Questions (FAQs)

1. Why two mutual funds in same category give different returns over 5 years?

Returns differ because mutual funds within the same SEBI category have different fund managers making distinct choices. Divergence is driven by stock selection, the number of stocks held (concentration vs. diversification), portfolio turnover, cash holdings, and minor differences in expense ratios.

2. How does the expense ratio impact on returns same category funds?

The expense ratio is deducted directly from the fund's NAV on a daily basis. If two funds hold the exact same stocks and generate the same gross returns, the fund with the lower expense ratio will naturally post slightly higher net returns for the investor over time.

3. What is style drift and why is it dangerous?

Style drift occurs when a fund manager moves away from the fund’s stated investment objective—for example, a large-cap manager aggressively buying risky small-cap stocks to boost short-term returns. It is dangerous because it secretly alters the risk profile of your overall asset allocation.

4. How can I check the portfolio overlap same category funds?

Many financial platforms and your Mutual Fund Distributor can provide an overlap analysis. This tool checks the underlying stocks of two different funds. If the overlap is above 50-60%, you are essentially buying the same stocks twice, which defeats the purpose of diversification.

5. Why shouldn't I just buy the fund with the highest past returns?

Past performance does not guarantee future results. The fund that topped the charts last year might have taken excessive, concentrated risks that paid off temporarily. A sudden market correction could wipe out those gains. Evaluating risk-adjusted metrics like Alpha and Sharpe ratio is much more reliable.

6. Do macroeconomic factors like RBI repo rates affect all funds equally?

Not necessarily. While RBI monetary policy and repo rate adjustments broadly impact the stock market, funds heavily weighted in banking, auto, or real estate (interest-rate sensitive sectors) will react much more sharply than funds heavily weighted in IT or pharma.

7. How do true-to-label mutual funds SEBI rules help me?

SEBI's categorization rules ensure that when you buy a mid-cap fund, you are genuinely getting mid-cap exposure (at least 65% of the portfolio). This standardization prevents asset management companies from misrepresenting their products and helps you plan your goal-based investing with accuracy.

Don't Leave Your Wealth to Guesswork

Choosing the right mutual fund requires more than just skimming through return charts. It demands an understanding of the manager's philosophy, the portfolio's underlying risks, and strict alignment with your life goals.

With midfin360, you never have to make these complex decisions alone. Enjoy a seamless digital transaction experience paired with the invaluable advantage of regular plan guidance.

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