How do I know that I’m invested in the wrong mutual fund?

Posted: 12 Sep 2012 04:12 PM PDT

Sorabh had posted a fairly lengthy comment a few days ago, and I really don’t know the answer to all his questions or even the primary one which was how you go about reviewing your mutual fund portfolio but I do have some thoughts (which are probably fairly obvious to everyone) on how to identify a mutual fund that you should get out of.

First, here is the comment (edited) for context:

Sorabh September 2, 2012 at 12:06 am [edit]

Hi Manshu,
Can you do a write up or invite someone to do a write up on "How to Review your Mutual Fund Portfolio", the standard statement that I read and listen to is invest in MFs and review your portfolio in every 6 months. I am not sure how do I go about reviewing it.

For example, it’s now two years that invested in SIPs in certain funds, some of the funds were giving a return of 30% few months back but i didn’t do anything about it. In fact I am not sure what to do, do I just shave off the profit only?

Then do what with that profit, put it in a debt fund? Or put that profit in my worst performing fund? or do I completely sell off that fund, then what do I do with a lump sum?

I don’t want to invest the whole sum in another MF, as I may be getting a bad deal at that time. Do I use SWP? When do I use SWP? When do i kick out a fund?

They say when its performing below its index average…OK in what time? 3 or 6 months? also don’t I lose in getting the fund taxed if i pull the plug before 1 year?
So I am looking for you assistance to basically reveal some "MF juggling strategies" to make money in the long run. Because today after 2 years I see my whole mutual fund portfolio giving me 5% return, some of the funds in it are 30% profit , while some which were 20% profit 6 months back are at a 5% loss today. I am really banking on these mutual funds to help me retire. I don’t want to be disappointed when I am 60 because when you look in retrospect, investing a lump-sum 10 years ago in a fund is a better deal than a SIP in the same fund (we discussed this a while ago) so I am not sure about the strategy, with my broker taking 1.6% (ICICI Direct) my returns are in fact 3.5% today.

Regards
Sorabh

Can you do a post on this?

The one specific question that I have some thoughts and experience is which mutual fund I want to get out of, so I’ll take that up in this post.

When you invest in a mutual fund or ETF – there are broadly two decisions that you’re taking – first one is that you want to invest in this particular asset class so you could say that I believe that PSUs are going to do well, or I believe that blue chips are going to do well, or just that index stocks are going to do well, and that’s the first decision you take.

The second decision is within this space, which fund should you invest in and that question is a lot harder than the first one.

So let’s take the second question first.

In my mind, the first reason for dumping a fund is when it doesn’t track its underlying asset correctly. So, if you bought an infrastructure mutual fund which is doing much worse than the infrastructure index because they own a lot of banks, that’s one reason to get rid of the fund. It is not doing what it is expected to do and you want to get into something that is doing what it’s expected to do.

When thinking about this it’s important to understand that the fund should track its underlying index not what you think its underlying index is. I’ve seen a few comments that say something like my real estate funds are bad because they are worse than the index, but the real estate funds aren’t supposed to track the index; index funds are supposed to track the index. You chose real estate funds to track real estate so it’s the first decision that needs reviewing, not the second decision.

The second reason I think is when other cheaper funds come in the market, and you have more options than before. Gold ETFs are a good example of this where for some years GoldBees was the cheapest and had good volumes, but now there are many more with low expenses which had similar performance. So now there is no reason to just stick with GoldBees and you can look at owning other names as well.

If you bought an expensive, under performing fund to begin with then you can think of switching to something else. You may have not known about this factor earlier, but now that you know, you can get into something better.

Another reason is if you find something about the fund manager that changes your opinion of the fund and makes you uncomfortable, that’s a reason to dump the fund.

If I bought into a NFO and find that the fund never gathered much popularity and has low assets under management, I’d like to get out of such funds as it’s not likely that it will get much attention from the fund house and may be merged with another scheme.

I have written about all these factors earlier as well in my post on under performing funds, and my belief from that time hasn’t changed that the gains you will make from your mutual funds will be because the market did well, and that’s an assumption that you are making – that the market will do well over long periods of time. If you weren’t making that assumption then 100% of your money would be in equities (which I assume it’s not) and there’s just no way to get around this fact.

You may look at your mutual funds in despair if they have returned only 3.5% in two years but if the market has also returned only that much then what else could an equity mutual fund do? It’s not the fault of the mutual fund in that case, and I don’t see a lot of point in churning funds.

The time frame also needs to be longer, if you look at time to retirement, that’s probably 30 years, but you want to make a decision on the fund in 3 months – that’s a bit lopsided. You need to see the funds at least for a year to get any sense of what they’re doing.

My own opinion on this is it is neither practical nor possible to zero in on the best fund year after year in a category and if you have something which is close to the underlying index then that’s good. Most of your gains will come in by being in that asset class and not because you own the best fund in that category. Of course, it’d be great to be in the best fund, but then how do you do that?

Now, to the first question – which is should I be in this asset class at all? That’s up to the reason of why you invested in those assets in the first place, and have those reasons changed. If they have changed, then you change, else stick with it.

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