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When is it the right time to say Goodbye to your fund?

The last few days have been extremely turbulent and volatile for the Indian financial markets. Stock markets have been moving up and down in crazy frenzy moves, bond yields have been galloping upwards resulting in falling bond prices, precious metals (gold and silver) hitting new multi-year lows and the striking of them all – the Indian rupee hitting all time life time lows. Keeping up with the current mood, lot of investors would be contemplating to sell and exit their mutual fund investments. Hence, the title of today’s topic is not when, how and in which fund to invest but actually when to sell your mutual funds.


For most investors, especially those with equity exposure and long term perspectives, buy-and-hold is the easiest strategy and one that has proven effective on a historical basis or atleast this is what they have been taught by the mutual fund managers, their distributors, analysts and media. If we study the last 120 year of US stock market history there have been periods wherein markets don’t give any returns for as long as 10 to 20 years or more. Similar, is the case with bonds as well as other alternate asset classes like gold. Hence, a pure “buy and hold” strategy might, contrary to popular opinion, not be the best strategy. For example, the Indian stock markets as represented by the BSE Sensex was around 21000 in January 2008 and as I write this note in July 2013, it is around 19500 – giving no returns or slightly negative returns over a 5 ½ year period!


Hence, there is a time when selling a fund is not only a bad idea but prudent as well. Obviously, you don’t want to marry your mutual fund, as things may change even if you are a long-term investor. There are times to admit a mistake and go on with your life.


The reasons to sell a fund can be two fold, those related to you as person, who has a definite investment objective in mind as well as a certain risk tolerance and of course reasons related to the fund’s management and its performance.


Coming first to some "You" related reasons:


Why you bought the fund in the first place - If it is not fulfilling its purpose or in case it has already fulfilled its purpose, it may be a time to sell. Was it for the medium term, long term or short term, depending upon what type of fund it is? In case you had bought it with a shorter term horizon in mind, say to finance your new car, or some furniture etc-go ahead and sell, but not at a loss of course. Also in case the appreciation you had expected has happened in a shorter while than expected then it doesn’t matter so go ahead and sell. Taking the reverse side into account, in case you had bought for long term so as to cream capital appreciation, or for its past dividend record and it has slipped up, then there is no reason for you to hold the same.


Change in your personal circumstances or Investment objective - If you are now in a different stage in your life where you are getting closer to retirement, you might want to sell that aggressive growth fund for a more sedate growth and income fund. Evaluating your fund's performance -- along with your financial situation -- every year is the critical first step in your decision-making process .


Change in your Investment Life Cycle - Thirdly again depending on your investment life cycle stage in case your long-term goals have now become short-term, shifting assets to more conservative investments may be required, so there is no harm in shifting from equity funds to debt funds.


Change in your risk tolerance - Lastly are there changes in your risk tolerance, so there is a mismatch between your and the funds’ risk profile. The change in the risk profile could have happened due to change in personal circumstances, or due to age, change of job etc.


Now let us shift focus to the Fund related reasons as to why one would want to sell their fund units.


Comparison of the fund vis-a-vis its own self - Obviously a fund should be sold due to poor performance. Be careful not to sell a fund because of poor short-term performance. One bad quarter or even a sub-par year isn’t sufficient justification to ditch a fund, especially if it has a good long-term performance record. Usually two to three years of unexplained or dramatic underperformance are appropriate indicators.


Comparison vis-a-vis other Funds - No doubt that selling funds that underperform their peer groups can lead to slight improvements in portfolio returns. It is important to base your decision on relative performance. You should compare the fund’s performance against other funds which have similar investment objectives or strategies. Also, when evaluating fund performance, make sure you compare your fund with the most appropriate peer group. Comparing "apples to apples" is the only fair way to see if a fund is doing well or underperforming.


Change in the Fund’s investment objective - In case there has been a change in the fund’s investment objective or strategy you are justified in selling it. If you bought a fund for exposure to large blue-chip companies and all of a sudden it starts buying small start-ups, that’s a definite red flag! Or if you bought a fund that buys undervalued companies and it starts buying companies at any price whose earnings are growing rapidly – another red flag.


Change at the Top - Change in man at the helm is always an uncomfortable thing. If a fund manager who is responsible for the performance record of the fund decides to leave for greener pastures, that may trigger an alarm. If this is the case, don’t automatically sell. Give the new fund manager time, particularly if they have a similar investment philosophy as the previous manager. If fund performance starts to falter after a year or two, it may be time to get out. If the new fund manager has a different investment strategy, you may consider selling.


Fund Expenses - Sometimes funds become too expensive. Many a times fund expense ratio rises significantly, particularly in bond and money market funds. Increases in fees to the manager represents a reduction of income to you and is unlikely to be offset by higher returns. Look at moving to a lower-cost alternative where expenses will not be a principal factor in the fund’s performance.


So remember always do your homework and keep track of the market. Review and evaluate your fund performance regularly and periodically. Although change is inevitable in life but don’t just change the fund just for the sake of changing – only change when there is a need to change, either due to change in circumstances from your side or from the fund and market side. Happy Investing!


- Mehrab Irani
The author is the General Manager - Investments with Tata Investment Corporation Ltd.

SENSEX   | NIFTY  

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