When to say goodbye to your Mutual Fund

When to say goodbye to your Mutual Fund

While there are many investment consultants, some by profession, some self-professed, who suggest on when to invest in a particular avenue, there is a certain paucity of people who talk of when to exit. People looking to invest get in many options and mutual funds happen to be one such preferred destination for people who want more returns than their fixed deposits would earn them. It’s also a preferred option for the people who are circumspect about investing into stocks directly and believe that mutual funds can manage risks and funds better than they could.

The recent crash will have several lessons for the investor but will not drive them away from the mutual funds in the wake of falling returns because they still are among the best investment avenues available to them. The primary of the lessons learnt is, not to chase returns. One of the biggest flaws in the process of investing is to chase the performance of funds alone. While they do give an indication to how well a fund can perform, they remain just indicative, for all good reasons. Take for example, the case of several equity funds that were riding sky-high between October 99 and March 2000. Alliance Equity Fund posted absolute returns of 168 percent between October 1, 99 and March 7, 2000. Birla Advantage posted 125 gains and ING Growth Fund posted mind-boggling returns of 193 percent during the same period. The recommendation by the consultants still remained "buy". However, investors who chased the returns of these schemes have learnt the bitter and eternal truth that "what goes up must come down", the hard way. These funds have posted negative returns of 64 percent, 61 percent and 82 percent respectively since peaking on the same day, March 7, 2000. And so, while chasing hot funds might be a good idea in a market that has started to rise, it certainly is a sure recipe to doom in a peaking market. The only people to have gained from investing in these schemes were the ones who exited while it was still profitable.

The others did not know when to exit and so we are just trying to put forward some situations when the investor should consider withdrawing their investments from the funds.
Fund is not performingThis reason for selling, although valid in certain conditions, is where most investors make a mistake. When calculating performance one shouldn’t look at too short a period and make a mistake by comparing apples to oranges.

It is important to base the decision on relative performance and not absolute performance. When one fund is down 5% while other funds or the market in general are up 10%, it is very tempting to switch over to what is "hot." Chasing Performance is the best way to shoot oneself in the foot as we just discussed above.

When studying relative performance, one should look at his fund and compare it to its peers. However, comparisons should be drawn between parallels and so equity funds can not and should not be compared with debt funds. When choosing a benchmark, one must select funds in the same category. If one’s fund was down 2% and the average equity fund was down 4%, then there is no good enough reason to sell it. One should compare the returns posted by his fund with that of the peers across various horizons such as 1-year, 3-year and above. A short-term view can often lead to committing hara-kiri, as it doesn’t present the full picture. If it has underperformed the average of its peers in all cases, then it sure is one of the better reasons to exit from the fund.

A change in life stageInvestments are done with a certain objective in mind and life stages are often a determining factor of what a person needs. A young man can afford to take more risks than a person nearing his retirement can. In such cases, it pays to withdraw money from the equity investments made earlier and put them in safer, more conservative debt funds that offer stable returns without compromising on risk. So a change in life stages would be one such reason to consider switching into a fund that matches with one’s needs. As one nears retirement, one might want to consider more conservative funds. If one gets married, one might need to compromise one’s risk tolerance and desired returns with that of the spouse. This could trigger off the need to exit.

A major change in any basic attribute of the fundWhen the fund changes any basic attribute as mentioned by it in its offer documents, the investors have a choice of getting out of it. Even SEBI has provided for an exit route being made available to the investors. Changes like a change in Asset Management Company or in investment style of fund or change of structure say from closed-end to open-end etc. are good enough reasons for an investor to consider switching or exiting from it as they are certainly likely to affect the fund in a major way.
Fund doesn’t comply with its objectiveOne of the important parameters in the selection of the fund is alignment of the risk profiles of the investor and fund. The objective of the fund says a lot about how the fund plans to invest. If the objective is not being complied with, it is one of the exit points worth considering. For example, the three funds discussed above, Alliance Equity, Birla Advantage and ING Growth all claim to be diversified equity funds yet they had huge exposures to select ICE sector scrips that not only added volatility than is expected out of diversified funds but also in a way, went against their stated objective.

The Fund's Expense Ratio RisesA small rise in an expense ratio is not a big deal, however a significant rise can result in substantial reduction of yields and so it would be better to exit the fund. In the case of bond funds or money market funds, it is highly unlikely that the fund can increase its returns enough to justify an increase in the fund's expenses.

The Fund Manager Has ChangedA simple change of fund managers, in itself, is not enough reason to sell a fund on a short-term basis. If it is a passively managed fund (index fund), then one has little to no reason to worry. However, if it is an actively managed fund, then has to keep the eyes open on the new manager. Observing the styles, stock picking and risks undertaken by the new manager is important for it discloses a lot about how the fund might fare in the future. If satisfied, one will have no reason to complain later but the process needs time and so an investor has to observe the fund manager for some time before one takes a decision.

Enough has been earnedHowever, nothing is as important as to rein the horses in time. The primary principle behind safety of investment is to take risks that can be tolerated. The principle also is specific on the expectations that the investor must have from any investment. Just as it is important to set realistic targets that one hopes to achieve from the investment, it is also important to exit when target as expected has been achieved irrespective of the fact that it might be generating better returns in a short-term. Waiting longer might not prove beneficial, as one need not be lucky all the time. Equity investments are volatile and it doesn’t take long for the moods in the markets to swing either way. So, it would only be wise to move out when the going is still good. Otherwise, the investors sanguine of generating even higher returns than what the fund generated in its peak days, would be cursing themselves for not exiting.
The above list is certainly not exhaustive and individuals will have other better reasons to quit as well. It’s just that most don’t know when to apply thought and so these would come in handy.
Source: Mutualfundsindia Research Team