Expert advice

Oct 11, 2013,14.27 IST

Is it time to say goodbye to your fund?

Many investors are still to fully understand the concept of a mutual fund. They continue to treat it similar to investing in shares. Therefore, they tend to buy mutual funds for wrong reasons - low NAV of a fund; dividend announced by a MF; New Fund Offer etc.

The same misconception is seen in selling too. One of the most common instances of selling a mutual fund has been to invest in a New Fund Offer. This is under the false impression that a fund at Rs.10/- is cheap and an excellent opportunity to invest. Many investors have been misled by distributors into this kind of switching.

Further, the profit booking strategy for stocks may not strictly be applicable to mutual funds. It is the job of the fund manager to keep buying under-valued or fairly-valued stocks, while booking profits by selling overvalued stocks Therefore, by selling a MF from a profit booking perspective, we may actually be selling off a fairly valued portfolio - with a good long-term potential.

Therefore, what could be the possible situations for selling a MF?

Financing a need A very obvious reason to sell would be when you need money. We all invest money with a view to finance some need or a desire in the future.

Say, you planned to buy a car or a house; or need to pay your child's fees; or maybe you want to take a vacation abroad. All this would require you to liquidate some of your investment.

However, proper choice is essential in deciding which fund(s) to sell. You could either sell those funds, whose performance has not been encouraging; or those where the tax impact is minimal; or those where the amounts are not very significant; etc. Or sometimes, possibly it may be better to borrow rather than sell a good investment.

Poor performance

There are more than 200 equity funds and their number is growing. The returns from practically all funds have been comparatively quite good, given the current bull-run. Even the worst performing funds have given 30-35% returns in last 1 year. In absolute terms these are excellent returns. But when compared to the top performers with 110-115% returns, these look extremely poor.

However, the key here is to look at long-term returns - 1-yr, 3-yr & 5-yr - and compare it with both the benchmark index and other funds in the peer group. In the short term there could be a genuine reason for under-performance. Some of the investments may be from a long-term perspective; certain sectors may have been under-performers; contrarian investments take time to catch market fancy, etc.

But if the performance of the fund continues to be consistently below par over long periods of time, then it may be worthwhile considering switching over a better performing fund. If possible, one should also try and assess the reasons for poor performance. This will give a good insight into the market.

Rebalancing the portfolio

We all have a certain asset allocation across various investment options such as debt, equity, real-estate, gold etc.

A change in your financial position may require you to rebalance your portfolio. Suppose you are presently having a well-paid job and are unmarried with no liabilities. You can, therefore, take much higher exposure in equity MFs. But with marriage and kids your responsibilities may increase, which would require you to reduce you equity risk to more manageable levels.

Or the portfolio balance changes with time, due to different assets growing at different rates. Your equity portion may have appreciated much faster than your debt, distorting the original balance. Hence you would need to sell equity and re-invest in debt to restore the original balance.

Or maybe a new asset class has been introduced in the market - a real-estate fund or a gold fund - and you want to take advantage of it. Thus you may have to sell a part of your existing investment and re-invest in this new asset class.

Change in taxation policy

A change in the tax policy could become a reason to sell and reinvest somewhere else.

Suppose our risk profile is such that we can take around 50:50 equity to debt exposure. Thus we had invested in the balanced funds. But, in the recent budget, the tax laws have been changed wherein a fund would classify as an equity fund only if the equity component is more than 65%. Therefore, the balanced funds would have to increase the equity component to 65% so that they can continue to enjoy the lower tax applicable to equity funds. But with 65% equity it becomes riskier. Hence, it could be time to exit.

Change in Fund-Style or Objective

We invest in a fund with a particular objective or style in mind. Suppose, we already have exposure in mid-cap funds and in order to diversify our portfolio, we choose a large-cap fund. However, after some time we observe that the fund is taking exposure in mid-cap sector too. This increases our overall exposure to mid-cap. Thus it may be time to sell and move to a truly large-cap fund.

Or say, we choose a fund for its' passive style of investing. But later the fund manager starts following an aggressive style with frequent churning. If this style does not suit our risk profile, it may be the time to say goodbye to such a fund.

Or take the case of some technology funds. These came at the time of tech boom and subsequently fared very badly. However, at Rs.4-5 NAV these looked quite attractive from a long-term perspective and some investors, confident of recovery in the tech sector, invested in these funds. But in the meantime, the AMCs in their anxiety to improve the performance of such funds, changed the investment objectives. This defeated the very purpose with which some investors had taken exposure in these funds; and hence had to consider exiting.

Change in the Fund Manager

When investing, one of the criteria is to evaluate the expertise, knowledge, experience and past performance of the fund manager.

However, while the fund manager is a key player in managing our money, one should not forget the contribution of the research team, the investment committee, the top management and AMC's investment philosophy.

Therefore, a change the fund manager need not necessarily mean exiting the fund. But it may be worthwhile keeping the fund under a close watch. If there is a perceptible decline in the performance, one could consider selling.

Change in the Fund's Size

Sometime the size of the fund starts affecting the returns. As we have also recently seen that certain mid-caps funds took a voluntary step to stop accepting fresh money into the fund, when the size became too large to manage. This is because (i) the mid-cap space is limited (ii) even small purchase of such stocks sent their prices soaring and (iii) too large a holding in such stocks will be difficult to offload when required.

Here, of course the funds took a proactive step to protect the returns of the existing investors. But if the funds themselves do not take such a step, we investors should keep track of the fund sizes.

The moment they become too large to manage or say too small to capture new investment opportunities, it may be time to exit.

There could, of course, be other reasons to sell, more specific to one's circumstances. The basic idea is to define, beforehand, certain rules for oneself for selling one's investments. This would reduce the day-to-day dilemma and ad-hoc decision-making, thereby make investing more scientific and unemotional.

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