Is a two-year slump a reason to sell your mutual fund? How to assess underperformance
I bought a mutual fund because it was one of the top performers when I invested. It has since underperformed for two years. How do I distinguish between a temporary period of underperformance and a fund that genuinely no longer belongs in my portfolio?
– Name withheld on request
Choosing a mutual fund can be overwhelming, and investing in a top performer may seem like a natural starting point. However, strong past returns do not guarantee future performance.
Our analysis of mutual fund performance over 13 years found that, on average, only 36% of the best-performing funds in one year remained among the top performers the following year. It is normal for funds to lose their rankings, so underperformance alone is not a reason to panic or exit.
Start with your portfolio
A lot depends on how the fund fits into your overall portfolio. Before choosing a fund, have a strategy in place. Decide how much you want to invest in equity and debt, whether you need large-cap, mid-cap, or small-cap exposure, and which fund categories best suit your financial goals and comfort with risk.
Once you have a strategy, shortlist funds across the categories you need and consider asset management companies (AMCs) with a strong track record. If you already invest in mutual funds, review your existing holdings before adding another. For instance, if a large share of your portfolio is already invested in large-cap stocks, another fund with similar holdings may add little diversification.
Check the consistency
Once you know what your portfolio needs, check whether each fund is meeting those needs. For example, if you hold HDFC Flexi Cap Fund, check how it has performed against its benchmark and other flexi-cap funds over different time periods, rather than focusing only on recent returns. Has it performed consistently year after year, or has it been lagging behind for a while?
If its performance has been weak, check whether there have been changes in the fund manager, the way it invests, or the stocks it holds. This can help you understand what may be behind its underperformance.
You can also check the fund’s quartile ranking to see how it has performed compared to other funds in the same category. If it has consistently remained in the bottom quartile for four to five years in a row, you may want to consider replacing it. However, if it has performed well for three years and had just one bad year, that alone may not be a reason to exit.
Most of this information is available in a fund’s factsheet, which includes its performance history and risk measures such as standard deviation and beta. An investment adviser can help you assess the reasons for underperformance and determine whether the fund still belongs in your portfolio.
Do not hold on to a fund simply because it was once a top performer, or rush to exit after a couple of difficult years. Assess its performance over time and whether it continues to serve your portfolio’s needs before deciding to stay invested or move on.
Feroze Azeez, joint CEO, Anand Rathi Wealth Limited
