Signs of under performing mutual funds

by Manshu on December 12, 2011

in Investments

Over the weekend I got an email from a reader who had a question on how to identify under – performing mutual funds, and in what way should one get rid of them.

I think this is a difficult question, and I don’t think there are any straightforward answers to it, but there are certain things that do come to mind.

Before getting to those things though, you need to ensure that you really are comparing the fund to its peers and not being harsh on it.

Remember, that an equity fund will only go up if the stock market has been up, and you can’t punish an equity fund for being down if the whole market is down. Small caps generally fall a lot more than large caps, so in down markets you will find that funds based on small caps are also down a lot more, and that’s not really a sign of under performance. The mutual fund is supposed to own small caps, and if it’s down as a result of that – then that’s really not the problem of the fund.

You need to evaluate the mutual fund against its peer group and if it has been down in that peer group, then that’s a sign of under performance, not otherwise.

Now, let’s look at some things that you can do to sniff out under performance, and let’s start with the obvious things first.

Was the fund sold to you?

I think the first thing you need to look at is why you bought a particular mutual fund, and have the conditions that existed when you bought the fund changed now. Looking at the huge volumes that mutual fund NFOs get, I think there are a lot of people who don’t really buy mutual funds, but they get sold to them.

If you have a fund that got sold to you, then it’s a good idea to evaluate how well it has done compared to its peers, and if there are other options with longer histories, and better performance then it makes sense to switch to those.

New information about the fund manager

If you bought the fund because of the fund manager and you find out some new information about the fund manager that makes you view him in a different light then that’s probably a sign of re-evaluating your decisions.

For example, Sandip Sabharwal is a well known fund manager in India and blogs as well. In going through his blog – I read a post where he discusses financial astrology and that made me view him in a completely different light, and I don’t think I will ever invest in a fund that he manages.

Thin Volumes

It’s always better to be in a fund with good volumes and a decent volume of assets under their management so if you are in a diversified large cap mutual fund which has just a fourth of the assets that another fund of similar type has, then it’s probably better to switch to that fund.

These were some obvious things, but what if the mutual fund has been a consistent performer in the past, but has started doing badly recently?

Is it high cost?

Look at the expense ratio of the peers and compare it with your fund – if it’s too high then that may as well be a reason of why the fund isn’t performing well.

If the fund expense ratio is high then that itself takes a big toll on the fund performance and it’s better to switch to low cost funds.

So, if you had something like HDFC Top 200, which is a good fund and you saw that it started under performing the market – how do you know whether you should give it the benefit of the doubt or should get rid of it?

If such a thing were to happen to one of my holdings, then I would like to see if the fund manager changed or not, and if they didn’t then I’d like to continue holding the funds, and give the fund manager the benefit of the doubt. But for how long? I will probably stick three years or so and in that time start investment with another fund as well, but I think if you have a shorter period then it is likely that you keep chasing one high return fund after the other.

I’d much rather be in a few high performing funds to start with, and that way the chances of all of them turning down at the same time reduces. There is no science behind this number of three years, just a feeling that this number is neither too short nor too long, and is a reasonable time frame.

I think a large part of the gains you get from equity will be because the market itself has done well, and a good fund manager may be able to juice up the return a bit but asset allocation and being in the market itself through decent funds is a more practical and achievable goal than trying to find the best fund within a category.

{ 15 comments… read them below or add one }

ANIL KUMAR KAPILA December 12, 2011 at 10:44 am

Hi Manshu
I think your following last paragraph is the most important of your post.
I think a large part of the gains you get from equity will be because the market itself has done well, and a good fund manager may be able to juice up the return a bit but asset allocation and being in the market itself through decent funds is a more practical and achievable goal than trying to find the best fund within a category.

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Manshu December 12, 2011 at 9:14 pm

I think eliminating mistakes and being in equities is a practical thing that one can do. By trying to get the absolute best mutual fund a person might just end up chasing a mirage and running up expenses that eats into all benefits.

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ANIL KUMAR KAPILA December 13, 2011 at 7:23 am

Hi Manshu
I agree. There is no thing called absolute best mutual fund. I am not aware of any fund which can consistently remain the best fund.

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Raja December 12, 2011 at 11:48 am

I liked your point on ‘new information about fund manager’. Earlier i didn’t even know who was the fund manager for the funds in which i was invested. But now i make sure i know the guy, read few reports by/about him and hear few interviews where i can get to know his views in general. And one such guy i liked after watching an interview is Kenneth Andrade of IDFC.

Regards
Raja

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Manshu December 12, 2011 at 9:15 pm

I think everyone should have some sense of the fund managers if they are investing in actively managed funds. It’s not very hard since a lot of these people do give regular interviews and you can Google them up and see if what they say appeals to you.

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ANIL KUMAR KAPILA December 13, 2011 at 7:34 am

Hi Manshu
Yes it is not difficult to know about the fund manager. For this it is very important that one should not have too many funds in the portfolio. Moreover selection of fund houses is also an important consideration.Good fund houses have systems in place and rely more on their research teams than only on star fund manager. If the fund house has systems in place then even if a fund manager leaves it will not materially affect the performance of a fund adversely.

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bemoneyaware December 12, 2011 at 12:14 pm

Very good question and very well written post.
As you rightly pointed out w.r.t equity funds we need to understand the big picture. Is the market going down? In last one year S&P CNX Nifty has given -15.60% returns while Sensex has given -15.74% so the funds which finally invest in stock markets should have comparable results. So most of the equity diversified funds have been doing bad.

I want to bring to light a fund which is under-performing. Reliance Growth Fund is an equity diversified fund which fits into Equity: Mid & Small Cap. It’s benchmark is BSE 100
It’s Trailing Returns As on 09 Dec 2011 (Ref a=”href=http://valueresearchonline.com/funds/newsnapshot.asp?schemecode=183″> Reliance Growth Fund on valueresearchonline.com
Fund Category
Year to Date -22.20 -19.97
1-Month -7.61 -7.81
3-Month -5.48 -8.96
1-Year -17.47 -15.04
3-Year 24.66 28.24
5-Year 8.49 5.15
Return Since Launch 25.40 —
Returns upto 1 year are absolute and over 1 year are annualised.

Reliance Growth Fund few years back was darling of the investors. (Infact it’s 10 year SIP returns are highest 26.70%). But this fund has been losing rating on valueresearchonline.com. It is now a three star fund. And often recommended to redeem Tracking performance on valueresearchonline.com

Would u redeem such a fund which has a pedigree and past performance to boost?
Personally I have invested in Reliance Growth and have not redeemed it and still tracking it.

Selling a fund is as difficult a decision as buying one

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ANIL KUMAR KAPILA December 12, 2011 at 5:24 pm

My feeling is that selling a fund is more difficult a decision than buying one. I am also invested in this fund for the past two years and have not been able to sell it so far. Opinion about selling this fund is divided. Some experts are advising to get out of this fund and others are saying to remain invested.

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Manshu December 12, 2011 at 9:20 pm

Just based on the returns – no I would not because it’s trailing by a couple of percentage points in one year – that’s not much at all, and is probably due to just one or two stocks in their portfolio.

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Mayank Gupta December 13, 2011 at 12:42 am

Answering to “How to get rid of under performing mutual funds” – while reviewing mutual fund portfolio once a year, one must change his non performing funds (not all under performing funds in a portfolio) to good performing funds. Changing funds cant be considered as booking a loss as we consider booking a loss after selling a stock in loss

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Manshu December 13, 2011 at 2:01 am

In writing this post, I completely forgot about that question.

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ANIL KUMAR KAPILA December 13, 2011 at 7:52 am

Hi Mayank
After reviewing the funds in my portfolio if I find that a particular fund has under performed consistently I just stop additional investments in that fund and invest in another performing fund. If I can find a good fund of the same fund house I just make a switch. I resort to redemption only if I need money.

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bemoneyaware December 13, 2011 at 11:33 am

Was wondering what to do after one realizes that the fund is under-performing?
How much time should one give-1 quarter, 2 quarters?

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ANIL KUMAR KAPILA December 13, 2011 at 2:20 pm

This has no clear cut answer. Personally I see the performance of all funds in my portfolio. If I see that a non performing fund forms the core of my portfolio and materially affects its performance I will try to get out of a non performing fund quickly. If however the non performing fund forms the satellite portion of the portfolio and does not significantly impact its performance then I will probably give it more time.

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bhushan kumar January 6, 2012 at 11:22 am

why don’t you yourself become a fund manager. you seem to know a lot about fund management. what everyone should be doing. you seem to be know all and end all about funds. why not show us how you will perform. easy to critise others. but when it actually comes to performing people like you are no where to be seen…

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