What should you do when your mutual funds underperform?

On September 27, 2007, the BSE Sensex had hit the 17000 level (on closing basis) for the first time. The index has been lingering thereabout even 5 years later in 2012 without any real movement. Grievous fall of the market for the reasons now known even to the most reluctant investor took the index to 8000 levels in March 2009. However dramatic recovery happened thereafter, rekindled the aspiration of wealth creation among investors but unfortunately it didn't last long as the range bound markets frustrated them over and over again. It was quite a crucial phase for mutual funds as they got no real support from the market which tested the fund management abilities of fund managers. Some funds have made their fortunes while others have lost their charisma. The total folios held by retail investors under all equity oriented schemes put together, in March 2012 were 9.4% lesser than the number of folios held by them in March 2009. Clearly the investors' interest is drying but their behaviour has remained more complex than one would imagine. In this article we have analysed how investors have responded to the performance of mutual funds and also have tried to answer the most commonly encountered question of how to deal with an underperforming mutual fund.  

Report Card

 

	6 Months	1 Year	2 Years	3 Years	5 Years
Total Number of Actively Managed Funds	251	247	233	218	187
Funds outperforming BSE 200	123	165	146	143	96
Funds outperforming BSE 200 (%)	49%	67%	63%	66%	51%
Funds outperforming Category Average	121	123	131	114	93
Funds Out performing Category Average (%)	48%	50%	56%	52%	50%

 

 

 

 

 

 

 

 

 

NAV Data as on June 29, 2012(Source: ACE MF, PersonalFN Research)

We analysed 251 actively managed funds with a minimum performance record of 6 months. However there were only 218 funds with a track record of more than 3 years. The number further reduced to 187 of funds with a track record of 5 years and above. The table above shows that the best performance from actively managed funds has come over the last 1 year as the percentage of funds outperforming BSE 200 was highest during this period. However, the striking difference in the number of funds outperforming the benchmark and the category average over a 3-Yr period shows that the top performers have far exceeded their peers and the benchmark index, taking the average returns higher. But subsequently only half of the funds have outperformed BSE 200 over last 5 years without any major deviation in the number of funds outperforming the benchmark and the category average which shows that there were a few outperformers. This brings out the fact that in the long term, only the consistent performers aid in generating wealth for its investors.

Since, now we know that there a few mutual funds which help generate wealth in the long term, it would be interesting to see how investors respond to the underperforming funds which are large in number and also in the degree of underperformance.

There can naturally be 4 responses when a fund underperforms.

1) Investors stop investing in the fund and redeem their investments in search of better options.

2) They buy better performing funds but they don't sell the current holdings anticipating one day their fund will catch up with the market

3) Some investors may buy underperforming funds more aggressively thinking they would benefit from rupee cost averaging.

4) The last natural response is they redeem underperforming funds and prefer to sit outside as they feel selecting a right mutual fund is too difficult a task.