What is the ideal time to exit from a badly performing mutual fund? (2024)

Santosh Navlani, COO, ET Money

When you invest in equities, you should be ready to witness ups and downs in the short term. You will have to deal with the nature of the beast. However, your fund's volatility will depend on its category and market conditions. For instance, a mid-cap fund will be much more volatile than a large-cap fund. Therefore, it's imperative to ensure your fund is an underperformed.

If the fund returns fall when the stock market goes down, and other funds, too, see a similar trend, you cannot call it underperformance. So what constitutes underperformance? If you have invested in a diversified equity fund, compare its performance to the benchmark and category average.

You can call it an underperformer if it is lower than both for at least two consecutive years.So, monitor the fund if it underperforms its benchmark and category for one year. Exit it only if it continues to underperform for another year.Investors must avoid sector and thematic funds as they are highly volatile. They can give high returns for a year or two and underperform for many consecutive years.

Gautam Kalia, Senior VP and Super Investor at Sharekhan by BNP Paribas

Mutual fund investment is for long term but the investor should review his portfolio regularly. While reviewing the fund performance, the investor should not only look at the point to point performance but should look at the rolling returns of the fund compared to its benchmark along with the risk adjusted performance. If the fund is performing poorly in these parameters, then substitute funds should be looked at.

S. Ravi Promoter & Managing Partner, Ravi Rajan & Co. LLP

It's important to remember that all investments come with a level of risk, and it's impossible to guarantee positive returns. When markets are volatile, for eg; the impact of the Russia-Ukraine war has impacted the investors wealth related to mutual funds. However, if a mutual fund is consistently underperforming and failing to meet its objectives, it may be time to reconsider the investment.

Before making a decision to exit a mutual fund, investors should evaluate their financial goals, risk tolerance, and investment time horizon. They should also consider consulting with a financial advisor to get a better understanding of the fund's performance and potential future outlook.

Investors should not make hasty decisions based on short-term fluctuations in performance but should re-evaluate their investments if a fund consistently underperforms its benchmark over a period of 2-3 years.

Alekh Yadav, Head of Investment Products, Sanctum Wealth

The exit decision shouldn't be based solely on the performance. Every investment style goes through phases and hence May underperform in certain market situation. The investor needs to ascertain whether the underperformance is because of an investment style not working or because the fund manager is deviating from stated philosophy.

If a manager deviates from stated philosophy, also called a style drifts, it generally is a clear sign to exit. If the underperformance is because of the investment style not working, then investors need to understand if reason for the same is temporary or structural. If it's structural then that's yet again a reason to exit.

Rahul Jain, President & Head, Nuvama Wealth

A mutual fund can perform poorly in two ways. It could be due to a poor market or the fund manager's scant fund management skills. If the reason is the former, investors should continue to invest. However, if poor fund management is dragging down performance, investors should immediately exit the fund and reinvest in a fund with a proven track record of performance.

Investors must evaluate the fund differently to distinguish between market and fund manager-led underperformance. If the fund outperforms the underlying benchmark, the market is to blame. However, if the fund's performance lags behind its respective benchmark and peers over multiple time periods, investors should take notice. They must exit the fund immediately if the underperformance can be attributed to inferior stock or sector selection and poor market entry and exit timing.

Aniruddha Bose, Chief Business Officer, FinEdge

The thumb rule for exiting a mutual fund is to not exit it in a hurry! Many investors end up exiting a fund based on short term outperformance (9-12 months) only to discover that the fund that they redeemed didn’t just recover, but outperformed the pack over the next few quarters.

Investors often end up redeeming outperformers because their frame of reference is incorrect. For example, small caps or the technology sector may have underperformed in a particular year compared to large caps. However, your small cap fund may have fallen the least!

So, exercise caution while evaluating your fund’s performance by choosing the correct frame of reference. If your goals are long term, you should resolutely continue your SIP’s in that fund because the turnarounds can result in explosive capital growth in a short period of time, and you don’t want to be sitting out.

Some red flags to consider while exiting a fund are – material changes in the fund management team, consistent deviations from trueness to label, inordinate amounts of speculative risks being taken (for instance, penny stocks or junk bonds), turmoil within the AMC such as a change in ownership that is resulting in changes to the AMC’s core philosophies, etc. Besides that, if your fund is consistently languishing in the bottom quartile for 8-12 quarters, you may want to have a chat with your advisor on whether its still suitable for your goals or not.

Girish Jain Associate Professor – Finance Birla Institute of Management Technology

Investment in equity mutual funds through SIP is a basically long term investment and a one or two of bad years should not discourage investor. Equity markets in short terms may be chaotic but long term trend should be positive. A research by WhiteOak MF shows that for 8 yearlong durations, chances are 100% for a positive return for SIP.

Poor performance may be due to bad market, compare the difference between the scheme return and the benchmark return. If poor performance continues for 2-3 years, investor may look at the following issues before deciding to exit:

1. Is there a change in fund manager and the underperformance is because of change in investment style?

2. Nature of MF scheme is changed because of any reclassification/recategorisation done and as investor you are not comfortable with the new classification.

Benchmark index may itself be generating negative returns during the period and investor should give time to a scheme to perform.

Sapna Narang,Managing Partner, Capital League

It would be advisable to monitor for a few quarters relative to the benchmark and peer group. A discussion with the fund house will further map out reasons for underperformance and will help understand if there is any change in philosophy or team. Also at Capital League, we consider an exit if our outlook on a particular category or sector changes.

However at any given point in time, a well balanced client portfolio will have a mix of schemes which will simultaneously outperform and underperform depending on which segment of the market is performing. For example: Growth vs Value OR Large Cap Vs Small Cap. In such cases, I would advise against an exit.

Suman Bannerjee, CIO, Hedonova

It is generally recommended to exit a poorly performing mutual fund if it has consistently underperformed its benchmark over a sustained period of time, typically 1-2 years. Investors should also consider the reasons for the poor performance and evaluate if those issues are likely to persist in the future. It is important to remember that past performance is not indicative of future returns, and investors should always consult with a financial advisor before making any investment decisions.

Satyen Kothari, the founder and CEO of Cube Wealth

Deciding when to exit a poorly performing mutual fund depends on factors such as the fund's performance relative to its benchmark, consistency of poor performance, changes in fund management or strategy, risk profile, investment goals and time horizon, diversification, and costs and fees.

If the fund consistently underperforms its benchmark or peers, shows no signs of improvement, has experienced changes in management or strategy that have negatively impacted performance, poses an excessive risk, is not aligned with your investment goals or time horizon, lacks diversification, or has high costs and fees, it may be appropriate to consider exiting the fund.

It's important to review the fund's prospectus, consider your individual financial situation, and consult with a qualified financial advisor before making any decision, taking into account potential tax implications and fees associated with selling mutual fund investments.

Ujjawal Pahwa, Content Creator - Finance, CS

Before exiting a mutual funds consider the following points:

A) Check - Underperformance period - if the market is in a bull run and the fund is not able to deliver returns consistently then you should consider shifting. However the consistency of underperformance should be checked for at least 18-24 months and not on near term basis

B) Compare Fund’s performance with other funds in the same category: For example if you have invested in a Digital funds that invests mainly in IT companies. The other fund in similar category are giving returns but your fund is unable to perform or meet returns till the industry average then you might consider shifting.

C) Compare fund’s performance with that of market: Say in a situation where the market has given negative 12% return but your Fund gave negative 4%. Here your fund has done well

Don’t be afraid to switch funds as they help you to book losses (in some cases) which can be used to set off gains/profits in your Income tax returns.

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Published: 14 Apr 2023, 06:18 PM IST